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Written by David Dierking for The Motley Fool
For the first time in years, investors might be better off taking the certain yield from long-term Treasuries over the uncertainty with equities.
Long-term investors could still prefer the higher return potential of equities, but there's no guarantee they'll outperform bonds.
More conservative income seekers might prefer the safety of Treasury bills rather than bonds even though they come with a lower yield.
Just five years ago, the Fed Funds rate was 0%. Three-month Treasury bills were yielding 0.05%. Even the 10-year Treasury yield was a meager 1.5%.
Needless to say, the bond market offered very little to income seekers unless you were willing to venture out into risky longer-term junk bonds. Worse yet, yields had almost nowhere to go but up from there, making eventual losses a high likelihood.
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Today, the fixed-income environment is different. It took some pain to get there, but bonds offer a legitimate risk/reward consideration when compared to stocks. The 10-year Treasury yield just crossed the 5% threshold for the first time since 2007, meaning investors can lock in a (theoretically) risk-free yield of 5% annually for the next decade.
And that poses an interesting conundrum for investors. Do you buy a 10-year Treasury bond, take the 5% yield, and call it a day? Or do you choose the S&P 500 (SNPINDEX: ^GSPC), assume the volatility that comes with it, and try to capture a higher return?
Several years ago, the choice would have been easy. Today? Not so much.
The appeal of buying a Treasury is that you know the return you're going to get.
For example, if you buy a $10,000 10-year Treasury note at par value with an interest rate of 5%, you know that you'll collect $500 annually in each of the next 10 years. That's assuming you hold the bond until maturity and get your $10,000 back. These bonds, however, fluctuate in value, which means if you sell at some point along the way, what you can sell that bond for may generate a capital gain or loss.
Now compare that effectively guaranteed 5% annual return with a similar investment in the S&P 500. Over the long term, the index has generated a roughly 10% average annual return. In absolute terms, that would seemingly favor investing in stocks over bonds, but there are two things to consider:
In Let's Make A Deal, that's the equivalent of choosing door No. 1, which has a known 5% annual return, or door No. 2, which could have a new car or it could have a donkey. That's the risk you're taking.
There's no one-size-fits-all answer to this question. But we do know there are a couple of factors to consider:
If you don't like the downside risk of stocks or locking your money up with a 10-year bond, there's another option: Treasury bills.
The iShares 0-3 Month Treasury Bill ETF (NYSE: SGOV) currently yields 3.6%. And it comes with complete flexibility to buy and sell at any time with very little share price fluctuation. You give up some yield compared to a 10-year Treasury, but that might be worth it to you, depending on your risk tolerance.
Personally, I still have a 10-plus year time horizon, so I'll be sticking with equities. But a 5% yield as an alternative did make me pause and think for a moment. I'm still choosing the long-term growth story. But for income seekers looking for more certainty, today's 5% yields on long-term Treasuries are certainly a compelling alternative.
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David Dierking has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends iShares Trust-iShares 0-3 Month Treasury Bond ETF. The Motley Fool has a disclosure policy.