Treasury yield: The most important economic metric

This is a guest post by Sam, author of Financial Samurai, “How to Engineer Your Layoff,” and founder of the Yakezie Network. 

Finance and investing don't have to be complicated. Consistently buying low and selling high can make you rich beyond your wildest dreams. Of course, if investing were so easy, we would all be kicking back and letting our money work for us instead of slaving away at the office every day.

When I started working on Wall Street in 1999, it felt like I was drinking from a fire hydrant because I was inundated with financial metrics. As a good institutional equities salesman, I should know the latest GDP forecasts to get a grasp of the overall macro momentum of the country. I'd then need to be able to speak eloquently about inflation expectations to differentiate between real and nominal growth. Finally, I'd have to drill down to a stock's specific sales, operating profit, net profit, and margin assumptions to figure out whether the company was a buy or sell.

After a couple years of what felt like groping in the dark, pretending like I knew more than I really did, I finally found one metric that was more powerful than the rest. By studying this one metric thoroughly, I was able to confidently talk to investment professionals 20 years my senior in a reasonably intelligent manner. I dare say that this one simple metric encapsulates almost everything there is to know about finance.

I'm not going to promise you after reading this series of articles that you will suddenly become an investing guru. What I will say is that hopefully this article will help you see the financial world with anti-glare, polarized lenses. By seeing things more clearly, you can drastically improve your chances of making profitable investments. With more profitable investments, it's only a matter of time before you achieve your financial goals.

Introducing the 10-year Treasury yield

The 10-year Treasury yield is the yield on a U.S. government Treasury bond. The U.S. government regularly issues Treasury bonds to raise money to help fund the national budget. In case you don't know, the U.S. budget has been in a massive deficit of $1 trillion-plus for the past five years. Only in 2013 are we actually forecasted to see a deficit below $1 trillion, thanks to economic growth, increased tax receipts and slightly lower spending.

As of August 2013, the largest holders of U.S. Treasuries by country are China, Japan, Brazil, Taiwan, and Switzerland, according to treasury.gov. Foreigners buy U.S. debt as a way to diversify their own investments as well as to recycle the proceeds they receive from their exports to America, such as, Chinese-made toys sold in the U.S.

The 10-year Treasury yield is also known as the risk-free rate. Why? The reason is because the U.S. government is considered the most solvent, credit-worthy country in the world, despite running a massive budget deficit, and in spite of the recent debacle on Capitol Hill. Just ask yourself whether you'd feel better buying a U.S. government bond or a North Korean government bond. Surely you would choose the former.

Part of the reason why U.S. Treasuries are so safe is because the U.S. dollar is a world currency which is also artificially manipulated by America's ability to print money. There's virtually no chance the U.S. will default on its debt because, when things get tough, the Treasury department can always print more money to pay off debt. When things get really tough around the world, foreign money buys even more U.S. debt. Without the printing press, faith in the U.S.D and U.S. assets would wane, leading to a massive depreciation of U.S. assets.

Now that we know the sanctity of U.S. Treasuries, we can dissect what goes into the latest 10-year Treasury yield which changes every single trading day.

What the Treasury yield tells us

Some of you might be skeptical about the power of one single metric, but please give me a chance to explain what the latest 10-year U.S. Treasury yield means for your investments and for your personal finances. Let's run through assumptions based on a 10-year yield at 2.7 percent.

Opportunity cost: Given you can make a 2.7 percent annual return doing nothing with no risk, your investments had better provide a return greater than the risk-free rate of return due to risk. This 2.7 percent return is close to an all-time low — 1.6 percent was the low reached in the fall of 2012. In other words, your hurdle rate is also close to an all-time low, making the alternative — equities — much more attractive than if the risk-free rate was 10 percent.

When the risk-free rate fell below 2 percent, smart money was flooding into equities because the S&P 500 dividend yield alone was over 2 percent. With cheap valuations based on historical levels and a 2 percent market dividend yield, the risk/reward was to the upside for buying stocks and selling bonds at all-time highs. One should generally always look to buy stocks when the stock market dividend yield is greater than the 10-year bond yield. The same thing goes for buying CDs when their yields are higher than Treasury yields as well.

Inflation expectations. Everything is Yin Yang when it comes to finance. Interest rates rise due to the expectation of higher inflation and fall when there is an expectation of low inflation. With a 2.7 percent Treasury yield, we know that U.S. inflation is therefore no greater than 2.7 percent because nobody will buy a bond with a 10-year duration if it provides a negative real rate of return.

To illustrate, let's say the Consumer Price Index (CPI) is currently at 4 percent. If you buy a 2.7 percent yielding bond, your real return would be negative 1.3 percent (2.7 percent minus 4 percent) a year so long as inflation is at 4 percent! The only reason you would buy a 2.7 percent-yielding bond when inflation is at 4 percent is if you believe inflation will drop below 2.7 percent quickly or may even go negative as in a period of deflation. Deflation is a very difficult economic situation where the expectation of a decline in prices leads to further declines because nobody is willing to buy anything when they can wait for cheaper prices in the near future. Deflation is often feared most by the Federal Reserve, followed by hyper-inflation.

If you understand the 10-year Treasury yield, you have an idea, more or less, of where inflation expectations are at any time in history. In 1990, the 10-year Treasury yield was around 9 percent. That means inflation was running likely between 6 to 9 percent a year. Pretty neat, right?

It's important to note that there is no inherent bad or good Treasury yield number. If Treasury yields are high, then asset inflation is high, which is good for asset holders and bad for price takers. When Treasury yields are low, asset-light investors are hurting less and should use this time to accumulate more assets.

* Risk appetite. If investors are accumulating bonds with yields below 2 percent, that means there is a “risk off” mentality. Investors are willing to accept under 2 percent annual returns because something bad must be going on in the world to run away from equities, which have historically returned 8 percent. Look at how Treasury yields dropped during the dotcom bubble, Gulf War, SARS epidemic, and housing crisis. Investors were basically screaming “save me!” as stocks and real estate declined.

If investors aren't willing to buy US Treasuries yielding much higher levels such as 8 percent, it must mean that there's a “risk on” mentality where there are potentially much more lucrative investments from which to choose. There may also be the expectation of much higher inflation and, therefore, higher rates due to perhaps an extremely loose monetary policy and a very tight labor market. Treasury yields can tell the overall market's risk appetite.

* How the world sees the US. As we discussed earlier, foreigners are huge buyers of US Treasuries. The lower the Treasury yield, the more accepting the financial world is of the United States — otherwise foreigners would be selling Treasuries instead. If the United States suddenly threatened to launch nuclear weapons against Canada and Mexico to expand their footprint, Treasuries would sell off in a hurry and yields would spike.

The problem with being a big holder of US Treasuries is that if a country like China ever wants to sell, they may cause a huge dislocation in the Treasury markets. Hence, foreigners are almost stuck into continuously buying our debt even when yields are so low.

There is a lot of angst against US foreign policy, but the important thing to focus on as an investor is watching what institutions do with their money and not what they say.

* Profit opportunities. There is a big world of macro investors out there who move a lot of money. George Soros may be one of the most famous macro investors who broke the Bank Of England by shorting the pound and making a billion dollars in 1992. I don't recommend macro investing until you've got a good grasp on economics and finance, but you can be your own “mini” macro trader with the 10-year Treasury yield.

I'm a big fan of exchange traded funds (ETFs). The easiest 7-10 Year Treasury bond fund is the un-leveraged ETF IEF by iShares. IEF goes up when yields go down (Treasury prices go up). If you want to profit from rising rates (falling Treasuries), then you can buy the inverse bond ETF TBF called the ProShares Short 7-10 Year Treasury.

For those who are confused with the inverse relationship between bonds and yields, here is a simple example:

Bond Yield = Coupon Payment/Bond Price

  • Bond price = $100
  • Coupon payment = $10
  • Bond yield = 10 percent

If the bond price goes down 50 percent to $50, the coupon stays at $10, then the bond yield rises to 20 percent ($10/$50 = 20 percent).

If the bond price goes up by 50 percent to $150, the coupon stays at $10, then the bond yield falls to 6.7 percent ($10/$150 = 6.7 percent).

US Treasury bonds should be a part of every person's portfolio. You can buy bonds to profit, hedge, or reduce volatility in your portfolio. Always check whether you need to “re-balance” once a year.

So there you have it. The 10-year Treasury yield, can give you a good idea of your opportunity cost to invest, where inflation is at any given point, and how you should feel about risk. It can also provide insight into how US foreign policy may affect markets and how to identify profit opportunities. Pretty powerful stuff if you ask me!

Treasury yields and your net worth

Feeling financially emboldened yet? The easiest way to track the 10-year Treasury yield is on Yahoo Finance. Now that you can speak more eloquently about economics and the stock markets, let's drill down to how the 10-year Treasury yield can help you make the proper net worth asset allocation.

I'm a big believer in not only diversifying your stock portfolio but also in optimizing your net worth as it grows in value. Once you build a sizable financial nut that is spitting out a viable passive income stream, your goal is to protect it like Sparta!

Real Estate

Most home buyers take out a mortgage to finance their property purchase, and understanding that the 10-year Treasury yield is closely correlated to mortgage rates is critical information for them. When the 10-year Treasury yield was at 1.6 percent, for example, one could lock in a 30-year, fixed-rate mortgage at 3.5 percent or a 2.5 percent 5/1 ARM. With the 10-year yield now over 2.6 percent, mortgage rates have risen commensurately by roughly 50 basis points to 100 basis points.

When Treasury yields are low, the demand for borrowing money increases. Much of the demand for cheap money goes toward property. As demand increases, so do property prices all else being equal. In a low-interest-rate environment, one should look to lever up and buy real assets which have the potential for appreciation such as property. Nothing is guaranteed (as we all know from the housing crisis), but cheaper mortgages means the opportunity cost of not owning property increases as rents rise.

Treasury Yields have risen violently in 2013 from 1.66 percent to as high as 2.98 percent recently. And while 2.98 percent is still low by historical standards, the pace of increase caught many home buyers and bond holders by surprise. This is why bond funds got smashed during the summer of 2013. Such a quick increase in rates should serve to dampen demand and price increases in real estate until the economy “catches up” to new, higher rates. Remember to always think about increases at the margin.

By keeping track of the latest 10-year Treasury yield, you think much more rationally and much less emotionally during a property-purchase or property-sale situation.

My current property asset allocation: 35 percent of net worth. Goal is to reduce the weighting to 30 percent by selling one of my rental properties due to a rebound in property prices and my desire to simplify life. Real estate is my favorite investment class for building long-term wealth.

Stocks

With the 10-year yielding 50 basis points (bps) more than the S&P 500 dividend yield and the S&P 500 at record highs, I am no longer 100 percent allocated toward stocks (equities) in my rollover IRA. I've decided to limit my equity exposure to 75 percent equities and 25 percent bonds within my investment portion of my net worth.

One of the saddest situations was when retirees in 2007 to 2009 saw their portfolios get decimated by 30 to 50 percent. I wrote a post in 2012 on GRS entitled, Finding Hope In The Bleakest Of Situations where I, too, lost about 35 percent of my net worth in a matter of months after 10 years of 50-percent-plus savings. Everybody thinks they are stock market geniuses in a bull market. But as Warren Buffett once said, “Only when the tide goes out do you see who's naked.” Don't confuse brains with a bull market!

The historical performance of the S&P 500 is, thankfully, up and to the right. But there are nasty corrections in between. We'll never know for sure when the next bear market cycle will be, which is why we should reduce exposure to stocks the closer we are to retirement.

My current stock/bond asset allocation: 30 percent/10 percent of total net worth. If the 10-year Treasury yield breaks 3 percent, I'll be shifting to a 25 percent/15 percent allocation.

Safe Assets

Safe assets include money market accounts and certificates of deposit (CDs) up to $250,000 per individual or $500,000 per married couple thanks to FDIC insurance in case your bank goes under. You can open up multiple CD or money market accounts with different financial institutions if you have more than the $250,000/$500,000 to spread around. It is always important to have a portion of your net worth in safe assets because bad things happen in the markets all the time if you invest long enough.

About 25 percent of my net worth is currently allocated in 7-year CDs yielding a blended 4 percent annual return. This was a fantastic rate when the world was coming to an end in 2008 to 2009, but not so much now that we've been seeing double-digit returns in the stock market for the past several years. A 4 percent CD yield is still much greater than the current 10-year yield of approximately 2.7 percent, but CDs also don't have a chance for principal appreciation.

When your CDs expire, invest in CDs that provide an interest-rate equivalent to at least the 10-year yield or greater due to inflation. The best CD rate I can currently find is a 7-year term at around 2.35 percent. As a result of low CD interest rates, I'm looking at CD-investment alternatives to boost return.

My desired CD allocation over the next three years: 25 percent of net worth going down to 15 percent or less.

Cash

Cash is a safe asset that deserves a section of its own. They say “cash is king,” but not so much in a bull market as we are experiencing now. Cash should be viewed mainly for emergency liquidity purposes. Cash provides no return and the amount you have should be dictated by your daily or monthly operational needs. Given CDs are FDIC insured, holding too much cash is a sub-optimal strategy since you could be earning at least 2.35 percent risk-free.

To determine how much cash is enough, calculate a realistic emergency fund amount based on cash withdrawal rates over budget for the past three years. Of course, if you are expecting a large upcoming expense such as a wedding, graduate school tuition, a relocation, or an investment, allocate more cash accordingly.

Bottom line: The lower the interest rate on the 10-year Treasury, the lower the return on less risky asset classes. Reallocate your net worth toward higher-yielding asset classes.

Treasury yields and loans

So far we've been focused on using cheap money to invest in other assets that can potentially provide greater returns. But what if you are not ready for investing and are still digging yourself out of a debt hole?

In this current low-interest-rate environment, now is absolutely the right time to shop around for lower rates. The worst kind of loan is a credit-card loan because the average interest rate on credit cards is around 15 percent. Despite a drop in Treasury yields over the past 10 years, credit card interest rates have remained fairly stable. As a result, profit margins have expanded if we assume default rates stayed steady. If you've been responsible in paying your credit card bills on time, I urge you to call your credit card company now and negotiate a lower rate today.

Mortgage rates and car loan interest rates are much more closely tied to interest rates partly due to fierce competition. The car industry went through near death and needed to entice consumers to buy during the 2008-to-2011 period. As a result, zero percent car loans for three years were common just to move the product. I'm a big advocate of never taking out a car loan. I truly believe a car is the Number 1 personal finance killer for people today. To compound buying a depreciating asset with a loan that charges interest is just wrong.

One of the best rules of thumb for buying a car is to spend no more than 1/10th your gross income on the purchase price of a car. The 1/10th rule helps motivate you to save and earn more if you want a certain type of car. The rule also keeps people from overly destroying their finances since a car is guaranteed to depreciate and takes money away from investing.

Banks realized they were too strict in their mortgage-lending practices in 2010 and 2011, and they are now more aggressive in mobilizing their overcapitalized balance sheets. Unfortunately, industry reports are showing that the refinance boom is temporarily over with a spike in interest rates in 2013 due to perceived tapering by the Federal Reserve. With the nomination of former UC Berkeley professor Janet Yellen as the next Fed Chair, we should see a continued accommodative Federal Reserve based on her record. Watch the 10-year yield closely and consider calling your mortgage broker to check the rates if the yield goes below 2.5 percent again.

Unless you are taking out a loan to buy an asset that has a chance of appreciating, please keep borrowing to a minimum despite low rates.

Conclusion

If you keep track of the 10-year Treasury yield and master its underlying meanings, you should be able to get a much stronger handle on your finances. Use the latest 10-year Treasury yield as a benchmark for every single investment you make to help take emotion out of the equation. The goal is to one day build a large enough net worth so that your money is generating perpetual passive income based on your personal risk tolerances.

What is your asset-allocation strategy and how did you decide on it? If you have any questions on the 10-year government bond yield please feel free to ask.

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FI Pilgrim
FI Pilgrim
6 years ago

Great stuff Sam, thanks for the overview. Looking forward to part 2!

Financial Samurai
Financial Samurai
6 years ago
Reply to  FI Pilgrim

Me too FI Pilgrim! The post was originally one very long, comprehensive post, but for the sake of not boring readers to death about financial terms, we’ve sliced it into 2 or 3 parts. 🙂

Beth
Beth
6 years ago

An interesting read! I’m not in the U.S., but our economy is closely tied to your country’s. I would never have thought to look at this.

One question though: is the U.S. really the “most solvent, credit-worthy country in the world”? I mean, can you point to a source on that? I’m not trying to be critical — I’m curious. Seems to me there are many other countries with perfect or near perfect credit too?

Financial Samurai
Financial Samurai
6 years ago
Reply to  Beth

Hi Beth, each country should have their own Treasury Bond Yield equivalent, which follows very similar reasons for why it may rise or fall. Definitely go check it out and let us know what you come back with. Because the USD is a world currency, has a printing press, and is largest GDP in the world of ~15.6 trillion (China is second so far at 7.5 trillion), the US should be considered the most credit-worthy. if the US isn’t the most credit-worthy country in the world, well… it’s certainly not China or Japan (#3 GDP). If the US collapses… the… Read more »

Beth
Beth
6 years ago

Cool! Thanks for the response — I’ll check it out after work tonight.

I was looking at a list of other countries that have perfect or near perfect credit, and the U.S. is definitely the largest — and dare I say size matters? In Canada, we’re more concerned about how the U.S. economy is fairing compared to say Australia or Germany because of our close links. We have our economic advantages too, of course 🙂

Financial Samurai
Financial Samurai
6 years ago
Reply to  Beth

Yep, size definitely matters for world economics and finance. Stay warm this winter!

Bobby @ Making Money Fast and Slow
Bobby @ Making Money Fast and Slow
6 years ago
Reply to  Beth

Even more interesting on the creditworthiness, when the US was downgraded in August 2011, our Treasury rates actually went down (meaning prices went up) which is completely the opposite of what you’d expect. Investors actually trusted the US more after it was downgraded which just goes to show you that the US is still one of the safest investments in the world.

I just hope they unwind QE soon…the longer they push that decision out, the bigger an impact on rates it will have. I’d expect at least a percent or two sell-off on the 10-year.

Financial Samurai
Financial Samurai
6 years ago

That was quite a conundrum indeed! Just goes to show us that it’s all about expectations and relativity.

I’m a believer in low interest rates for a long, long time. Rates have been going down for 30+ years and I don’t expect them to go up huge again. Maybe a 1% rise to 3.5%-4%, but I’d be BIG against breaching 4% on the 10 year for the next five years at least.

El Nerdo
El Nerdo
6 years ago

I’d argue the rate is not “risk free” if inflation is eating it away at -1.3%

Besides, the government can always print print print more money, but the money would devaluate. Hence the returns are guaranteed only nominally, not in real terms.

Why I know this: I grew up in a country with hyperinflation. Yikes! (The only way to “save” what to spend everything immediately).

The real head-scratcher for me is: how do you beat inflation for your short-term cash needs?

Financial Samurai
Financial Samurai
6 years ago
Reply to  El Nerdo

I don’t think you can beat inflation with short-term cash holdings. It’s about losing less in real terms, or simply not losing money in absolute terms at all.

Because of low interest rates, I keep practically nothing in cash. Instead, I build a long-term CD ladder for such cash and spend the penalty free interest if needed.

Most people won’t need the CD interest income due to income from employment. It’s when we move into retirement where the balance gets trickier.

El Nerdo
El Nerdo
6 years ago
Reply to  El Nerdo

Late edit: I get it that you meant to say that the bond rates are higher than the expectation of inflation, otherwise people wouldn’t buy them, but I got thrown off by the paragraph that followed re: a CPI of 4, expectations of deflation, etc. Regardless– just because there is an expectation of inflation *under* 2.7% it doesn’t mean that’s what will happen over the next 10 years, right? So, here’s my real question– how good/accurate is that prediction usually, and for how long does it hold? I mean, is there a way to see a historical record of how… Read more »

Financial Samurai
Financial Samurai
6 years ago
Reply to  El Nerdo

Interest rates and Treasury yields move daily. We can only look at snapshots in time, and we can really only make educated guesses to the future. But if you pull up the historical 10-year bond yield and overlap it with inflation, you’ll find the correlation to be super tight. This post was much longer, and it should/may have that chart. If not, check it out on Yahoo Finance home page.

El Nerdo
El Nerdo
6 years ago

Thanks!

So, if the daily correlation is tight– wouldn’t it follow that it only makes sense to buy such bonds when inflation is high? (Because then bond rates will tend to beat inflation over the years as inflation comes down?)

Financial Samurai
Financial Samurai
6 years ago

#16 – Yes, that theoretically makes sense if inflation decreases. One of the big wins for bond investors is locking in long duration bonds with high yields during the crisis. But then it would have been better to go all in on stocks instead for a better return. It all depends on your risk parameters and what you are looking to return.

El Nerdo
El Nerdo
6 years ago

I’m looking to build an inflation-proof, highly liquid 1-year expense emergency fund (a must for freelancers). Say $25K.

A-L
A-L
6 years ago

El Nerdo,

You may want to look into TIPS or ibonds, from the federal government. Both are designed to provide inflation protection for your money.

Here’s a mini-primer on the issue: http://www.bogleheads.org/wiki/I_Bonds_vs_TIPS

El Nerdo
El Nerdo
6 years ago

Thanks A-L

I’m familiar with TIPS in the abstract but I don’t know how to buy them in a non-retirement sort of way. Secondary markets, etc. etc., sounds like a headache, but yes, I should probably focus in that direction for that purpose, and figure out a way. Thanks again!

Wordshark
Wordshark
6 years ago

So glad to see this post here this morning! I wish GRS would post more Advanced articles from excellent “third stage of PF” authors like Sam. I may be in the minority on this, but I find this way more interesting than “here’s how I saved $30 last month” type articles.

Money Saving
Money Saving
6 years ago
Reply to  Wordshark

I’ll second that! I find this kind of third stage stuff very interesting and actionable. Keep it coming!

Financial Samurai
Financial Samurai
6 years ago
Reply to  Wordshark

Thanks. What are the three stages of personal finance you are referring to called?

Don’t count me out on being able to write insightful articles on how to save $20 a year on shampoo!

Malcom
Malcom
6 years ago

The three stages our from an article the founder of this website JD Roth wrote. The article should be in the archives.

If I recall correctly the first stage is getting out debt, the second stage is growing your passive assests and the 3ird stage is management your assets.

Beth
Beth
6 years ago
Reply to  Wordshark

Me too! I need to learn more about investing so I find these types of articles really helpful.

Financial Samurai
Financial Samurai
6 years ago
Reply to  Beth

Cool. Well I’ll do my best to continue writing about investing and hopefully make it interesting and relevant enough to be digestable.

From a couple comments, it looks like I really need to spell some things out e.g. US consumers consume the most US goods when talking about China holding most of our debt.

PayOffMyRentals
PayOffMyRentals
6 years ago

For how much longer will the U.S. Dollar be the world currency? There seem to be some very real, concerted moves by Russia and China, etc. to dethrone the dollar. Much of this having to do with oil.

Do a Google search “russia and china against the dollar” and you’ll have more reading on the subject than time permits.

Financial Samurai
Financial Samurai
6 years ago

Probably for much longer than we will live. For our children, who knows. Maybe there will be multiple world currencies, which may be good b/c that would mean these countries have grown larger, stronger, and more trustworthy. We’re not all held prisoner by politicians on Capital Hill!

A lot of investors have diversified by buying Chinese assets. With the ever appreciating RMB, it’s been a smart move over the past 20 years.

Matt at Your Living Body
Matt at Your Living Body
6 years ago

Most credit worthy country in the world? It’s not a problem because we can just go and print more money? Excuse me while I go to Home Depot to get a wheelbarrow to carry my cash to buy a loaf of bread.

Financial Samurai
Financial Samurai
6 years ago

Which country or countries do you think are more credit worthy than the US and are you investing your money there?

Paul in cAshburn
Paul in cAshburn
6 years ago

Um, “Without the printing press, faith in the U.S.D and U.S. assets would wane…”?
Is this a misprint? Shouldn’t the statement indicate that the printing press could easily destroy faith in the USD (the opposite of what you appear to have said)?
After all, if everyone simultaneously decided the USD wasn’t a good store of value, the Fed could print all the USDs they wanted to, but they wouldn’t be worth much without “faith”.

Financial Samurai
Financial Samurai
6 years ago

As George Michael said, “Ya gotta have faith, a faith, a faith.”

Life is one big risk.

cathleen
cathleen
6 years ago

Maybe it should have said a “military juggernaut behind the printing press”.

James Schwabacher
James Schwabacher
6 years ago

I’m by far no expert, but I’m pretty sure the U.S. cannot simply “print more money to payoff debt.”

At least, that’s what I was going to comment until I did a little more research and read this: http://www.forbes.com/sites/pascalemmanuelgobry/2012/10/19/no-the-united-states-will-not-go-into-a-debt-crisis-not-now-not-ever/

I understand the system a little better now. Thank you for your post!

Financial Samurai
Financial Samurai
6 years ago

No problem! This stuff takes time to get our heads around, but it gets easier the more we talk, read, and write about it.

Mark Wang
Mark Wang
6 years ago

You mentioned it in very professionally way, and yes I am agree with you about that US Dollar is the world currency and it will remain world currency till long time .

mike
mike
6 years ago

“One should generally always look to buy stocks when the stock market dividend yield is greater than the 10-year bond yield.” In general I disagree with this statement and the analysis, for a number of reasons. 1.-I don’t like the concept of reaching for yield because of any specific metric. You should do what works for you based on your situation. In general, reaching for yield in and of it self doesn’t necessarily help the average investor. 2.- You can’t look at the yield environment in a vacuum and I wouldn’t make any assumptions about the future credit worthiness of… Read more »

Financial Samurai
Financial Samurai
6 years ago
Reply to  mike

Sounds good. What is the one metric you would recommend people follow to better understand the markets? I’d love to know your background in investing too as it sounds like you have a lot of experience. thx

mike
mike
6 years ago

No specific metric will help anyone understand the market. You could compile the 100 best metrics, it won’t necessarily help the average investor understand the market, it probably wouldn’t hurt either though to know the information. Here read this book its very helpful. It’s called “The Market(s) are from Mars, Human Beings are from Venus”. -Metrics aren’t gong to help with the emotional and psychological impetus behind investor actions. It won’t explain what a C.D.O. or Credit default swap is before it matters. They aren’t going to explain away how corporations tweak their numbers to show positive metrics and good… Read more »

Financial Samurai
Financial Samurai
6 years ago
Reply to  mike

Sounds good. The challenge I had for this post as a writer was to think of one metric, simplify it, and show how it relates in finance. The second half of the post is coming, but I’m not sure when.

What’s your background?

mike
mike
6 years ago
Reply to  mike

The post had some valuable info and I learned from it. I’m not trying to come down on you but I get wary when so much value gets placed on a single metric. Its like watching the cheerios commercials that state they may lower you cholesterol and improve your health because it has whole grains. Well, yes whole grains are one thing that may improve your health but in the big picture its just one factor in thousands some of which are uncontrollable/unknowable by the individual. Analysts were quoting metrics to buy at the top of markets and metrics to… Read more »

Larry
Larry
6 years ago
Reply to  mike

I think the goal is to identify one of the most important metrics, and distill it down to its essence so readers can understand how it associates with economics and investments as a whole. Your comment for example is very convoluted and hard to understand whereas the post is not.

mike
mike
6 years ago
Reply to  mike

The problem is Larry I have read atleast 100 articles explaining why 100 plus metrics are the most important and while the articles and information may have some value the assumptions they make that the metric brings order to chaos is misleading. Imagine you had to explain religion to someone who wasn’t familiar with religion. How would you start? What examples would you provide? Let say I decided to provide a clear example explaining Hinduism as an example of religion, distilling to its essence so readers can understand how it associates with religion. The readers may have an understanding of… Read more »

Untemplater
Untemplater
6 years ago

Very helpful explanations. It’s good to understand what the risk free rate means. Investing can seem overwhelming but it really isn’t when we take an interest in learning. Building a solid foundation of key concepts helps a lot and helps the harder aspects suddenly click. Great post!

Chris Gammell
Chris Gammell
6 years ago

I always feel compelled to mention that the top country in the world that holds US debt is not China…it’s the US! We buy a lot of our own debt (well, different institutions do). Lord knows there’s enough to go around though!

Financial Samurai
Financial Samurai
6 years ago
Reply to  Chris Gammell

That’s a good point. But unless there’s some type of unspeakable monstrosity the government conducts, I don’t think Americans are going to sell all US assets and flee the country. Maybe… but probably not.

Tim
Tim
6 years ago
Reply to  Chris Gammell

I’m glad you point this out, Chris. It always irks me when writers make this huge mistake. The US owns most US debt, and it’s not even close.

Financial Samurai
Financial Samurai
6 years ago
Reply to  Tim

Thanks for the feedback Tim. Although it’s too late for part II, I’ll be sure in my next post to not make assumptions such as people understanding US consumers are the largest consumers of US goods. I’ll spell things out more clearly. I just don’t want to bore people to death w/ minutiae and void people from understanding the bigger picture message.

Good luck with your chemistry PhD. Are you planning on being a professor or work in finance?

Tim
Tim
6 years ago

You think 68% is minutiae?

Jim
Jim
6 years ago
Reply to  Tim

I think the point is that it’s assumed Americans buy the most American debt. At least that’s my understanding.

Going to study the 10 year yield now! Thanks Sam!

Tim
Tim
6 years ago
Reply to  Jim

Jim, I wish that were the case. But many Americans believe China owns a straight up majority of US debt. It’s one of those economic myths that just won’t die: http://www.dailyfinance.com/2012/02/13/3-economic-misconceptions-that-need-to-die/

Tim
Tim
6 years ago
Reply to  Jim

Here’s an example of presidential and vice-presidential candidates making speeches with inaccuracies regarding China’s holding of US debt: http://www.washingtonpost.com/blogs/fact-checker/wp/2013/11/12/sarah-palins-claim-about-china-u-s-debt-and-the-foreign-master/?hpid=z4

Done by Forty
Done by Forty
6 years ago

Fascinating read, Sam. These sort of short cuts help me out a lot, as someone who doesn’t have a great mind for finance.

Financial Samurai
Financial Samurai
6 years ago
Reply to  Done by Forty

No problemo mate. I don’t have a great mind in finance either. I just have some experience.

Scondor
Scondor
6 years ago

The most I ever learned about forecasting the stock market came from a book titled The Strategic Bond Investor by Anthony Crescenzi. I’d say he’s probably on the same page as you regarding the simplicity, accuracy, and importance of the yield curve. He has a good chapter about it and I’ve been following FOMC meetings ever since. Great post Sam, I’m going to check out your blog for more.

Financial Samurai
Financial Samurai
6 years ago
Reply to  Scondor

Sounds good. Studying the bond market is tantamount to better understanding the equities market and vice versa. It’s like reading women’s magazines to understand what women see and want in men!

Rob
Rob
6 years ago

I had a finance professor explain treasury yields to my class in early 1998 this way:

Prof: “Look at these yields. Do you know what they mean? How many of you finance majors are juniors?”

Students: Confused, about half raise our hands.

Prof: “These yields mean that about half of you will be applying to law school.”

Financial Samurai
Financial Samurai
6 years ago
Reply to  Rob

Hah! Good one. I fear folks who go to 3 years of law school and spend so much money since 65%+ of folks don’t end up practicing law !

Chris
Chris
6 years ago

What happened to JD? Doesn’t he post on Thursdays?

Ellen Cannon
6 years ago
Reply to  Chris

Yes, he usually does, however this week he’s busy trying to finish writing his ebook to make his deadline, so Sam helped us out.

Micro
Micro
6 years ago

Really interesting read. I’m looking forward to reading the rest of the series. I never really considered how well things can be based off the 10 year treasury rate.

Natalie
Natalie
6 years ago

So should we be buying Treasuries right now?

Hypatia
Hypatia
6 years ago

Great article, I’m confused on a few points.
1) I’m pretty sure that the country holding the most U.S. bonds is the U.S. Right?
2) I’m confused by the terms “asset owners” and “price takers”. If, as I assume, asset owners are stock owners and they do better when inflation is high, is the case where divided yields exceeding bond interest an exception to that role?
I have no idea what a price taker is.

Financial Samurai
Financial Samurai
6 years ago
Reply to  Hypatia

1) Correcto. It’s about focusing on things at the margin in finance. Americans are already well aware of what’s going on in the US. It’s the X Factors of countries who hold our debt that we should not forget about. In investing, only a MINORITY float is traded and reflects the ENTIRE value. For example, Twitter raised a couple billion (float), but has a market cap 12X that which that float reflects. 2) Price taker = take what’s given to you and like it. A renter is a price taker for example. A asset owner is the landlord. For stocks,… Read more »

Roxie
Roxie
6 years ago

Hi Sam,

Thanks a lot for this. I’m starting to wrap my head around this – inflation and the ‘economic yin-yang’ have always been too confusing for me to understand.

It’s the second post on Get Rich Slowly focused on investing in the recent days and I think it’s great. Solid guidance here and in the portfolio post. Keep it up GRS!

Financial Samurai
Financial Samurai
6 years ago
Reply to  Roxie

No problem! It gets easier to understand the more you read about finance. I think you’ll like part 2 of the post where I apply the 10-year yield to more practical items in our lives.

Jon
Jon
6 years ago

Looking forward to the next installment. I haven’t directly invested in Treasuries, though they’re part of the mix in some of the mutual funds in my portfolio.

El Nerdo
El Nerdo
6 years ago

Hey, thanks for the article, lots to learn, but I’ll confess to be often led astray by my lack of knowledge of the jargon. Specifically, from article 1 and the intro here: It’s important to note that there is no inherent bad or good Treasury yield number. If Treasury yields are high, then asset inflation is high, which is good for asset holders and bad for price takers. When Treasury yields are low, asset-light investors are hurting less and should use this time to accumulate more assets. What are “price takers”? I read this: http://www.investopedia.com/terms/p/pricetaker.asp And I still don’t understand,… Read more »

Financial Samurai
Financial Samurai
6 years ago
Reply to  El Nerdo

Hola El Nerdo, The easiest way to think about this concept is in terms of real estate: * Real estate owner (asset owner) enjoys rising real estate prices. * Real estate renter (price taker) hates rising real estate prices. Not only will it take more savings and more income to buy, rent is also likely increasing because the value of real estate is the capitalized value of rent. But to truly be long real estate, you have to own more than one property. Owning your home is neutral real estate. Renting your home is short real estate. Owning multiple properties… Read more »

El Nerdo
El Nerdo
6 years ago

So I thought about it for a moment– is this just a sophisticated way to say “the haves” and “the have nots”? If so, I think I got it. Thanks!

john williams
john williams
6 years ago

This article gives the historic reality of bond pricing prior to the QE policies of the Fed and other central bankers. Today though with QE fueling an assest appreciation bubble due to the large amount of money being created by QE it is no longer valid. When central bankers slow down or end QE policies the artifically inflated values of assets will burst. Just look at the reaction of Wall Street to the hint that the Feds might ease QE policies. The stock market moved down. The decline will be even greater when QE is dismantled totally. Housing prices are… Read more »

Financial Samurai
Financial Samurai
6 years ago
Reply to  john williams

It’s the big question. How much will interest rates rise, and why are they rising as we discussed before? If the rise is due to a huge demand for money thanks to a robust economy, then my bet is on housing prices continuing to rise.

If the rise short term to counteract runaway inflation, housing prices will probably fall, but if there is inflation, by definition your housing assets are inflating.

Rates could rise by a couple %, but I think they stay low for a very long time e.g. 10 more years or until some exogenous shock happens.

Steven Le
Steven Le
6 years ago

Waiting for the next instalment Although there’s still much to learn after reading this article since further research is always needed.

Brian
Brian
6 years ago

I’d add that unless you’re using bonds to speculate on interest rate movements, you are far better off just buying Treasury securities directly than using ETFs or mutual funds. Most discount brokers charge nothing to buy treasuries at auction and you won’t incur the annual management fees imposed by all ETFs and other funds. It’s something anyone can do.

Financial Samurai
Financial Samurai
6 years ago
Reply to  Brian

You have to wait for the auction to happen, which may not be the most opportune time. But definitely another channel.

I find buying an ETF easiest. The cost is minimal.

Tim
Tim
6 years ago

Sam,

Good article overall. You have a few missing links between your supports, and your conclusions, though. In particular, you do a good job describing how “you can buy bonds to profit, hedge, or reduce volatility in your portfolio.” However, you do not connect that in any way to “US Treasury bonds should be a part of every person’s portfolio.” To do so, you’d need to show specifically when to buy or sell to profit. Take now, for example: are you buying or selling 10 year Treasurys, and why?

Financial Samurai
Financial Samurai
6 years ago
Reply to  Tim

Thanks. This article was original one big article to provide as a primer, but was later cut up into 3 articles. Some of my links were also removed as well that provided more meat for those interested. An article on when and whether to buy or sell bonds now might be something I will write in the future. Not sure how interested the GRS community is interested in this topic though. Take a look at my recommended asset allocation of stocks and bonds by age and work experience post as an example: http://www.financialsamurai.com/2013/01/28/the-proper-asset-allocation-of-stocks-and-bonds-by-age/ How many more years do you have… Read more »

Untemplater
Untemplater
6 years ago

Happy Thanksgiving! Very helpful explanations of the reltionship between bond prices and yields. Definitely makes it a lot less confusing to look at it with numerical examples. Thanks!

Natalie
Natalie
6 years ago

Interesting article although I don’t agree with your definition of yield. What you explained is known as the current yield, which is the coupon over the price of the bond. What fixed income investors actually quote as the yield can be either the yield to maturity, yield to worst, or yield to call. Yield in general is the interest rate that will equate the price that you pay for you security today to the coupon that you earn (assuming that you reinvest all of your coupons at that same unique interest rate) and the face value of the bond. It… Read more »

YR
YR
6 years ago

Thank you for this article, Its a lot better understanding treasuries and how they affect the markets. That bond price and coupon payment example was really helpful!

Snarkfinance
Snarkfinance
6 years ago

Tremendous advice and knowledge being shared here. I have admittedly been a little on the lazy side in terms of analyzing my net worth makeup and portfolio, although by no means are they currently out of whack (this motivated me to take another look). I too follow treasury rates closely due to my real estate investing, and would encourage others to do the same. Great article!

Financial Samurai
Financial Samurai
6 years ago
Reply to  Snarkfinance

No problemo. It’s always nice to do a NW review around this time of year. All about reflection. It’s what my latest post on FS is all about. We need to know how far we’ve come so we can plan for the future.

The Warrior
The Warrior
6 years ago

Hey Sam –

Regarding your stock suggestion of 25-30% allocation, do you believe index funds are the route most should take or just those that don’t have/want to spend time researching building a portfolio?

Obviously, one can diversify within index funds (i.e. international, bond, growth, etc.), but the product itself, what is your take on it?

Thanks for any advice!

The Warrior
NetWorthWarrior.com

Financial Samurai
Financial Samurai
6 years ago
Reply to  The Warrior

I’m definitely a fan of index funds and index ETFs. There are so many and you can diversify through them for sure. Keeping fees low is tantamount.

Brian @ Luke1428
Brian @ Luke1428
6 years ago

Thanks for sharing this Sam. I’m curious about the 25% you have invested in CDs. How did you come by that percentage? It seems like that’s a high amount to have allocated in the safe asset category. Is it because of your experience losing 35% of your net worth during the last big correction?

Financial Samurai
Financial Samurai
6 years ago

I’ve been investing around 35%-40% of my annual savings in CDs post college since 1999. The other 70% has been invested in real estate and stocks.

As stocks and real estate have grown, the CD portion has declined as a percentage of my net worth. As someone whose career, pay, promotion, and bonus was tied to the stock market given I worked on Wall St., I wasn’t going to be overly aggressive in investing more in the stock market.

Matt YLBody
Matt YLBody
6 years ago

I can’t wait for the next crash. It’s the best time to make money 🙂

jim
jim
6 years ago
Reply to  Matt YLBody

Why does everybody say they can’t wait for the next crash ’cause it’s the best time to make $? Is it because the prices drop so you can buy more shares? Just wondering.

Financial Samurai
Financial Samurai
6 years ago
Reply to  jim

Because everybody believes they have the guts, fortitude, and timing to buy when the world is coming to an end. But when the world is coming to an end, things such as your job might be at risk.

jim
jim
6 years ago

When the world is coming to an end you should buy more stocks? WTF? So you lose your job and the world is coming to an end, don’t you want liquidity to eat? Sorry, you’ve totally lost me on this. So, again, I ask why do people love it when the market crashes? Is it really just to buy more when prices are low?

Money Saving
Money Saving
6 years ago

Sam,

This is a great primer on how to set and change your asset allocation.

I’ve got very nearly the same asset allocation as you if you count my current home as a real estate investment. As we downsize our house, we may look into getting rental property down the road, but I really like the ease with which electronic investment instruments can be used (stocks and bonds) vs. real estate.

Financial Samurai
Financial Samurai
6 years ago
Reply to  Money Saving

Perhaps rent out your current house and buy a smaller place for you to live? I really like the idea of holding onto real estate for as long as possible.

Done by Forty
Done by Forty
6 years ago

I’m impressed with all the information that’s related to the 10 year Treasury metric. This is the reason I keep reading finance blogs: I get to learn. Thanks, Sam.

Financial Samurai
Financial Samurai
6 years ago
Reply to  Done by Forty

No problemo. Glad you enjoyed the series.

I have a feeling that learning about finance and economics is generally pretty boring. So hopefully this post helps tie in real life things as it pertains to the 10-year.

If everybody was interested in finance, perhaps we’d all be pretty well off!

Kristin Wong
Kristin Wong
6 years ago

Hey Sam!

Bookmarking and re-reading the series. For an investing noob like me, this is a lot of info, but you made it really accessible and easy to wrap my brain around–so thanks for that. I’m trying to develop a more sophisticated/involved allocation strategy, and your insight about the 10-year yield certainly helps. Thanks!

Financial Samurai
Financial Samurai
6 years ago
Reply to  Kristin Wong

Your welcome! Start early and invest often. You’ll wake up in 10 years and be like, “HOLY CRAP! I can’t believe I’ve got so much money!” It’s crazy what time does for our wealth.

Micro
Micro
6 years ago

Since I’m just really starting to build my financial horde, I pretty heavily invested on the stock side. I have a little bit in bonds and a little bit in REITs since I don’t have the capital to purchase any local housing (don’t even have my own house yet). This might get shifts a little bit in a couple years but for now I like the layout.

Jack Rubio
Jack Rubio
6 years ago

What is your opinion on penny stocks? let me know? 🙂 thanks

HealthyWealthyExpat
HealthyWealthyExpat
6 years ago

Great series, Sam. I always enjoy reading what others do with their asset allocation. Gold is always a controversial topic, and I notice that you don’t mention it. What do you think about gold as a small part of an investment portfolio (say 10% or so), given the current infatuation with money printing in the US, Japan, and Europe?

Financial Samurai
Financial Samurai
6 years ago

I’m very disappointed in gold… probably b/c it did so poorly in 2013. If the world is coming to an end, gold, cash, CDs will definitely outperform equities. My risk free assets are in CDs, and not gold b/c gold produces no income. I do like gold watches though!

Benny Profane
Benny Profane
6 years ago

“One of the saddest situations was when retirees in 2007 to 2009 saw their portfolios get decimated by 30 to 50 percent. I wrote a post in 2012 on GRS entitled, Finding Hope In The Bleakest Of Situations where I, too, lost about 35 percent of my net worth in a matter of months after 10 years of 50-percent-plus savings. Everybody thinks they are stock market geniuses in a bull market. But as Warren Buffett once said, “Only when the tide goes out do you see who’s naked.” Don’t confuse brains with a bull market!” Yeah, but, if you then… Read more »

Financial Samurai
Financial Samurai
6 years ago
Reply to  Benny Profane

Ah yes, hence the reason why I’m so bullish on the economy and why the doomsday media is so off. Like you say, everybody is invested in the stock market, has real assets, didn’t sell at the bottom, and has record high wealth now.

The key is to keep things low key and not brag too much about it. Stealth Wealth!

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