Why Treasury Bonds Make More Sense at Today’s Higher Interest Rates

Return to 2020. You have $1 million to invest in the Treasury market. A 10-year Treasury note yields 0.5%, while a 30-year Treasury bond yields 1.2%. Because the 10-year note would generate only $5,000 a year, the prospect of earning $12,000 may entice you to choose the 30-year bond.

 

 

Higher Interest Rates Changed the Math for Bonds

With the benefit of hindsight, we can assess both choices, and neither delivers an appealing outcome. The lesson is that risk involves more than the potential loss of principal; it also includes volatility. Although 30-year Treasury bonds carried no default risk, their exceptionally low yields left them highly exposed to price swings if interest rates moved higher.

Rates have risen sharply since 2020. With 30-year Treasury yields now at 5.5%, the $1 million investment is worth just over $400,000, while six years of interest adds only $72,000 of income. Investors who hold for another 24 years can look forward to eventually getting their $1 million principal back.

The 10-year note fared better but still fell to $830,000 while generating only about $30,000 in income. Accepting less income in 2020 would have actually improved the period’s total return by about$380,000. A money market fund, initially yielding about 0.1%, or $1,000 a year, would have preserved the $1 million principal while its income increased as interest rates rose.

The problem in 2020 was that bond cash flows had little upside and substantial downside. The market today illustrates how valuing cash flow can change.

Currently, a 10-year Treasury note yields more than 5%. Using our $1 million example, more than $500,000 is coming your way over the next 10 years, not counting the compounding interest. Unlike the last six years, the next six will yield more than $300,000.

The math has changed, and Treasuries are a better investment than in 2020. Could it still be a losing proposition in six years? Interest rates would have to approach 17%, which seems unlikely. It’s all about the cash flow; higher income provides a greater margin for error.

Why Cash Flow Matters When Investing in Stocks

Nvidia recently announced plans to increase its share-repurchase program by $150 billion over the next two years, described as the largest buyback authorization in history. While the headline figure is striking, its economic significance should be viewed in context.

With Nvidia’s market capitalization at roughly $5.5 trillion, $150 billion of repurchases represents less than 3% of the company’s equity value. Spread over two years, it is only about 1.4% annually. That is not immaterial, but it is unlikely to drive per-share value on its own.

This does not make Nvidia a poor investment. Rather, investors should place limited weight on the buyback announcement and focus more on the fundamentals that will determine long-term shareholder returns: revenue growth, AI-infrastructure demand, gross margins, competitive dynamics, capital intensity, and the durability of Nvidia’s earnings power.

We apply the same cash-flow evaluation principle to dividend-growth investing. Specifically, we seek to purchase companies with a cash-flow yield of at least 5%, a metric we are happy to discuss in more detail individually.

When that cash flow is also growing consistently each year, the potential for permanent capital loss over a six-year holding period becomes meaningfully lower. There are no guarantees in investing, but adequate cash flow that grows over time builds wealth.

Observations on the Market No. 423