There’s a new kind of “risk-free” investment on offer by governments around the world: Buy their bonds, and it’s guaranteed that you’ll get less money back than what you invested.
Throughout history, when you lend someone money (or anything else of value), they pay you interest for the privilege. After all, when you’re lending money, you’re taking a risk. There’s a chance the lender might not return your cash. And there’s an opportunity cost associated with lending someone else your money, as you could be doing something else with it. Earning interest is a way to get paid for taking on these risks.
“Time value of money” is a building block of finance. It’s the idea that money is worth more now than later – because money can earn money between now, and later. In normal times, you’d rather have $100 now, instead of $100 later. That’s because you could (in theory) put today’s $100 in a bank – and later get back that same $100, plus interest.
In many markets around the world right now, though, the time value of money is turned on its head. Your $100 today is actually worth less later, and instead of interest, some of today’s money is subtracted.
Right now, you could lend money to the German government (by buying German government bonds), and, in 10 years, get 99.98 percent of your original investment back. (And remember – with inflation, the buying power of your money, after 10 years, will be a lot less.)
There’s an even worse deal on offer in Japan, where 10-year government bond yields are at negative 0.2 percent (so you’d get 99.8 percent of your invested capital back). In Switzerland, you’d get 99.49 percent of it back. In the U.S., yields are close to all time lows, but still – for now – above zero.
(As we’ve written before, the notion of “risk-free” bonds generally relates to the chance of default – that is, that the borrower doesn’t pay back the lender. The Japanese government or the European Central Bank can, if need be, print more money to meet their obligations. But there’s still plenty of risk in “risk-free” bonds, in part because inflation eats away at returns.)
Why are investors still buying these bonds, even though they’ll get back less money after ten years – less than if they piled their money in a big cardboard box, and buried it in their back yard for ten years?
We recently wrote about the three questions anyone should ask himself before making an investment. The first of those is, why am I buying it?
In the case of government bonds that offer a guaranteed loss, the answer is simple: Because that loss is less than the potential loss from other investments.
Right now, markets are on edge. The possibility that Britain will leave the EU, concern over the Chinese economy and currency, questions about the U.S. central bank raising interest rates, and underlying weakness in the global economy – these issues are all spooking markets.
And when investors are scared, they go to so-called safe haven assets. Government bonds are usually the safest place to go – because they’re “risk-free.” They’re also liquid, which means they’re easy to buy and sell. They’re the closest thing to cash.
But in part because more and more money has flowed into bonds, and due to quantitative easing efforts by central banks, yields have collapsed. (In the world of bonds, price and yield move in opposite directions.) And as a result, many government bonds now offer negative yields.
As we’ve written before, cash is one of the best ways to hedge your portfolio. Now, what a lot of investors use as “cash” – government bonds – will actually cost them money.
This makes gold, another traditional safe haven asset, more attractive. Gold is a metal that doesn’t have a yield. But unlike many government bonds, at least it doesn’t have a negative yield.