Executive Summary: Cash and bonds offer strikingly similar yields today, which makes it tempting to think there's a free lunch in skipping bonds altogether. I walk through three frameworks for weighing the two and explain where I ultimately come down in the IVA Portfolios.
Why would anyone invest in bonds or a bond fund when the yield on a money market is close? It seems to me you eliminate the risk and get almost the same return. Am I missing something?
That’s a question I got from several IVA readers in response to my recent articles on bonds and cash (here and here).
The readers are picking at a basic premise of investing: Typically, you need to take risks to earn a return, and the more risk you take, the greater your potential profit (or loss). Money market funds (cash), with their stable NAVs (net asset value, a fund’s per-share price), have essentially no risk but currently offer yields similar to those of bonds, which are inherently much riskier.
In other words, it looks like there is a free lunch—in the form of picking cash over bonds—available in the marketplace today.
Let me be clear, I don’t know whether bonds or cash will be the better performer next year or over the next decade. Of course, you may think you have a read on where interest rates are headed. If so, then you might want to bet on it—go all cash or load up on long-maturity bonds.
I’m a realist. I know that I don’t have an edge when it comes to predicting interest rates, so let’s put guesses aside. Instead, let me give you some fundamental reasons why an investor might pick bonds over cash today—and then I’ll tell you where I land.