This is what the government bond chart on the Bloomberg site showed me recently:
- 2 years: 2.13 percent return
- 5 years: 3.13 percent return
- 10 years: 3.50 percent return
- 30 years: 4.38 percent return.
If you want to invest in bonds (these are U.S. bonds but you can do the same exercise with bonds from other countries), which ones do you choose? Here’s how to break this chart down in order to select the best deal.
1. Calculate the difference in the various interest rates in basis points. One basis point equals 1/100th of 1 percent or 0.01 percent.
- The 5-year bond’s interest rate is 100 basis points better than the 2-year.
- The 10-year bond’s interest rate is 37 points better than the 5-year.
- The 30-year bond’s interest rate is 88 points better than the 10-year.
2. Measure the points per year. (Divide the points by the number of years your money will be tied up.)
- In comparing the 2-year to 5-year bonds, you get 33 more basis points of interest for each of the three extra years your money is tied up.
- In comparing the 10-year to 5-year bonds, you get 7.4 more basis points for each of the five extra years your money is tied up.
- In comparing the 30-year to 10-year bonds, you get 4.4 more basis points for each of the extra 20 years your money is tied up.
The 5-year bond looks like your best deal – but it’s not. When you compare the 2-year to a zero-year bond at zero interest (in other words, no bond at all), you get 107 more basis points for each of the two extra years your money is tied up. Based on how much more interest you get paid for the number of years you tie up your money, that makes the 2-year bond your best deal.
The 30-year bond is your worst deal.
There are subjective factors you will also want to consider, like how soon you will need that money. But for a simple quantitative analysis… you just learned how to do it.
[Ed. Note: ETR's Investment Director, Andrew Gordon, is the editor of INCOME, a monthly financial advisory service that uncovers income-generating stocks that promise safety (first and foremost), along with much-higher-than-average profit potential.]
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