Why Shouldn’t You Buy Treasuries for Retirement?

Let’s start my first blog off (cheers!!) by giving a quick overview of treasuries before explaining my thoughts on buying them in retirement funds. When I talk about treasuries, I’m talking about owning American federal government bonds.

The government uses debt to finance their spending in conjunction with taxes, and they often do this through debt securities called bonds.

The government structures this debt instrument usually by borrowing a dollar amount from you, paying a fixed interest rate on the borrowed amount until the end of the loan, and paying you back the borrowed amount at the end of the loan term.

There is something quite great about loaning the American government money – you’re sure to receive the interest rate they promised and your cash back at the end of the borrowed term (nonexistent bankruptcy risk, unlike in other forms of bonds).

The American government can’t go bankrupt because they print the money that it borrows. As long as this relationship stays the same, they will always be able to pay you back what they borrowed from you.

Treasuries have been used as a primary wealth-building tool for the entire history of America.

Treasuries Have Poor Current Prospects as a Wealth-Building Tool

Let’s have a look at the current interest rates offered on US treasuries – as of 8-29.

This means that to loan the government money for 1 year; you will earn 0.068% interest. Extending your duration to 30 years changes that to 1.92% interest.

Spoken differently, the price to earnings multiple on a 30-year treasury is 52 ($52 invested gives you $1 per year). The interest is also a fixed amount that can’t grow.

This compares to a Shiller price to earnings ratio of 39 for stocks (2.56% earnings per year). This may seem pretty comparable, however with stocks, the earnings grow each year, and in a 30-year bond, you would miss out on 30 years of earnings growth.

We see a similar story when we look at real estate cap rates (effectively an interest yield). In the last quarter of 2020, American real estate average cap rates were 6.56%, meaning a price to earnings multiple of 15. So again, there is growth opportunity available for real estate in increasing rent prices over time, which is nonexistent for bonds.

Since investing is about not consuming now so that you can have more consumption later, let’s do a simple analysis of our three options to see what foregoing one Big Mac now will do for your ability to consume Big Macs in 30 years.

In this example, I will assume inflation is 2% a year, Big Mac price growth matches inflation, stock earnings growth is 2% a year, and rent price growth is 2% a year.

Big Macs Consumable Estimates

Well, well well – not only is the 30-year treasury bond a poor investment, but it actually loses money over time if the Fed government can keep inflation to its targeted 2% a year.

This is the massive risk in government bonds, the Federal government is actively trying to destroy your wealth through inflation, and you have no growth that can reverse the damage.

This same analysis holds for the other treasuries of shorter durations, except the results are even more extreme.

So what’s the deal? If this is such a bad investment, why do so many organizations own government bonds?

I can make a whole different blog about this (and perhaps I will), but to make a long story short, there are many forced buyers of bonds. A quick list includes banks, insurance companies, pension funds, college endowments, inheritance trust funds, and foreign governments (due to the US trade deficit).

Retirees don’t have to be included in this, but often they are.

Retirees often buy bonds, even at today’s unattractive rates, for two main reasons: to diversify their retirement fund away from stocks and reduce their holdings’ volatility.

Retirees Are Diversified Even Without Treasuries

One of the main reasons savers buy bonds into their retirement fund is because they don’t realize how diversified retirees’ assets are. So let’s look at one primary consideration: Social Security.

Savers often don’t realize that Social Security can be treated like a bond product that isn’t inheritable. Social Security gives a fixed monthly payment to retirees (like a treasury bond does), and it grows with inflation (much better than a bond!!). The average social security income was $1543/mo in January 2021.

We can attempt to value the asset value of payment like a bond by multiplying the yearly income by our price to earnings multiple of a 30-year US bond. When we do this, we find that this is an (uninheritable) asset of $963K!

Put differently, it would require investing $963K in a 30-year treasury to achieve the amount of Social Security income that the average retiree gets monthly. Retirees already HAVE fixed income, and they earned it from all their years of having Social Security taxes on their income while they were employed.

Retirees also own real estate, which reduces their expenses during retirement if they have one house. They also can create income if they own rental real estate property.

The average person over 65 has a net worth of $201.5K, of which $140K is in real estate, a whopping 70% of their net worth. The other 30% of their net worth is in financial assets. So why should savers put any of that average 30% of their net worth in an investment that gives them fewer Big Macs?

Let’s sum this up by looking at a breakdown of an average person of retirement age’s assets (note that I list here Social Security, though it is uninheritable).

Average Assets of Retirement Age Individual

Now, let’s consider what a substantially above-average saver’s asset allocation looks like. Studies have shown the top savers have about 60% of their net worth in financial assets other than their homes. So let’s take a look at the results for a saver with $1M of net worth with the same lifetime earnings as our average person.

Estimated Assets of an Above-Average Retirement Age Saver

Even for our above-average saver with $1M in net worth, they still fuel a massive amount of their retirement with fixed income from the government! So there is again a poor case for this saver to diversify into treasuries which won’t grow Big Mac consumption.

As savers, we should look to grow our money, not allow it to disappear for the sake of diversification – especially when we already work jobs that will result in fixed income from the government at the traditional retirement age.

Stock & House Price Volatility Impacts Are Reduced Due to Social Security

Now that we’ve built out this framework for viewing Social Security as a fixed-income product, let’s examine a worst-case scenario. Let’s rewind to 2008, when stock prices and house prices were in freefall. How would the asset values of our hypothetical savers be impacted during the biggest drops?

Average Assets of Retirement Age Individual Largely Unaffected

Above Average Saver Experiences Muted Drawdown

To sum this up, the fixed-income properties of Social Security significantly reduces volatility. Treasuries also reduce volatility but can’t be relied on for building wealth. Social Security is the only volatility-reducing diversifier we need in our portfolios.

Holistically viewing retirement assets can help retirees reduce panic during market downturns. Meanwhile, individuals currently saving for retirement should keep these charts in mind to pick their portfolio allocations.

Replace Treasuries With Stocks and Real Estate

So how should you move forward with this knowledge?

The first thing is to check your retirement allocations and make sure you’re saving into stocks. I’d recommend an S&P 500 index fund (and no, target-date funds don’t count, they have treasuries in their portfolio allocations).

Secondly, create a plan for buying real estate and develop an overall strategy for how you’ll work this into your financial roadmap.

Lastly, look for ways to increase your savings rate. High savings rates are the most important driver for retirement because they allow you to save more money while having fewer expenses to cover during retirement.