Bond Basics & History
Because a lot of people own bonds without understanding what they own. When you buy a bond, you are not buying a piece of a company. When you buy a stock, you own a piece of a company. You own a company. They agree to pay you interest, usually twice a year, and then return your original investment when the bond matures, right? That is a very simple explanation of bonds and that's essentially how most bonds work. Here's what trips people up.
Think of a bond price and interest rates like a seesaw. When interest rates go up, right? Because often because of inflation or some other reason, interest rates go up, bond prices go down. The value of the bond goes down because newly issued bonds are paying higher interest rate. When interest rates come down, bond prices go up because newly issued bonds are paying a lower interest rate, and so you've got this bond that pays a higher interest rate, and so now that bond has a higher value, right?
That's a relationship. And for about 40 years, that seesaw tilted in one direction the entire time. It was just like this. If you ever sat on a seesaw by yourself, it just stays in one position. And that's basically how it's been since I was born. In 1981, the 10-year Treasury had a yield of 15.7%. Now, that is a great return. The Fed's fund rate that same year hit almost 20%. What was happening was the Fed chair, a guy with the name of Paul Volcker, was trying to strangle inflation by making borrowing incredibly expensive.
What happens is the economy becomes really hot cuz if you have low interest rates, it spurs a lot of economic growth. Economic growth can often end up driving up prices because often there's a supply and demand issue, and so the Fed chair was trying to squelch the growth to bring prices down. If you were alive during that period, you remember we had runaway inflation in this country. And so what Volcker was doing was he was using interest rates to strangle inflation by making it incredibly expensive to borrow, so it slowed down the economy.
And it worked. Over the next four decades, rates came down, and they came down, and they came down all the way to nearly zero in 2022. And as rates dropped, bond prices climbed. People weren't just collecting interest anymore, they were also getting a price on the appreciation on top of the income, right? Because remember there's the seesaw, and so bond prices were going up. So, this is why you start to get total return bond funds.
Like PIMCO had these bond funds that were going up significantly in value. So, it wasn't any longer just about how much money you were making on the interest, it was also about price appreciation. That's why bonds became so popular. For years, people loved bonds. But by 2020, for a number of reasons, first the financial crisis and then the COVID crisis, yields had collapsed almost nothing. And one thing was obvious, there was nowhere for bond yields to go but up, right?
There was a period of time we were not using bonds for our clients. So, if we were, we were using ultra short duration. I remember talking to people and they're like, "What kind of financial advisor are you? You're not using bonds." And I kept trying to explain over and over again, when rates were at zero, they're going to have to reset upwards, and when they do, bond prices are going to get crushed. Your portfolio is going to get crushed.
You were better off leaving your money in cash or in some other instruments, right? Because when yields go up, prices go down. That's exactly what happened. So, in 2022, rates rose faster than almost anyone expected. The Bloomberg US Aggregate Bond Index, which is basically the benchmark for the entire US bond market, lost 13% that year. Can you imagine? You don't have to imagine, you lived through it, right? You've been sold bonds as being safety in your portfolio, and they're down by 13%.
That, by the way, was the worst calendar year for US bonds in the index's 50-year history. So, congratulations. Most of you watching, actually probably all of you watching, unless there's some very young children watching very boring content, you lived through this. Before 2022, the worst year was 1994. And in 1994, bonds lost less than 3% of their price. But here's what made it even worse. Morgan Stanley's research showed that a 60/40 portfolio, right, the safe haven where everyone put their money because they've been sold to 60/40 being a great place to retire, it fell 17.5% in 2022, which was the its worst performance since 1937.
It's fourth worst return in probably the last 200 years, the best we can figure. People who thought bonds were the safe part of their portfolio watch stocks and bonds fall together. That's not supposed to happen, at least at the rate it did. And if you were a year or two from retirement or you just retired or you were in retirement, you watched your supposedly conservative portfolio drop dramatically along with your stomach, right?
You felt it in the pit of your stomach. And so now a lot of you watching are incredibly skeptical about fixed income. Now, interestingly, what Wall Street did is they used this as an opportunity. I think it was Rahm Emanuel quote that says something like never waste a crisis. Wall Street saw this as an opportunity begin selling people very expensive alternatives. There was this massive explosion in people being interested in alternatives in people's portfolios.
Lots of big firms were selling alternatives. And Wall Street loves alternatives because as there had been fee compression in the broader market, right, ETFs had come down to basically zero cost, alternatives on the other hand paid a large premium, often 2 to 3%. And so you saw this explosion in private credit, which is now beginning to have its own problems and may end up unraveling in really destructive ways, but that is for another video.
So what Wall Street did is when people were afraid of bonds, they're like, "Hey, we have something better for you. It's expensive, but trust us, it's safe." Now we're wondering if it's actually as safe as we were told, surprise, surprise. But here's the part that no one in the financial media comes back and revisits.