3. Opportunity Cost
Another chief risk bonds carry is the high opportunity cost involved. Opportunity cost* refers to the cost incurred by not enjoying the benefits associated with the best alternative choice. McCutcheon (2019) provides strong evidence by showing the historical returns of investors in three different scenarios over a 40-year period (1979-2019) a) Investments made in stocks only b) Investments made in bonds only c) Investments made in both stocks and bonds.
He revealed to us that if we invested $100,000 in each situation,
a) Only stocks – $100,000 would become $7,540,000
b) Only bonds -$100,000 would become $1,590,000
c) Stocks and bonds- $100,000 would become $4,840,000
McCutcheon (2019) says that most people own bonds because they get some peace of mind. However, he says that such a mindset will cost investors highly evident from the opportunity cost involved in investing in bonds only. The opportunity cost in this case cost millions as the other two choices were more attractive. Dalio (2020) further says that under current conditions, it would be “pretty crazy to hold bonds” as the interest rates offered currently are insignificant. He says that investors would be better off buying other assets such as stocks and commodities like gold or silver, which provide enough return to keep ahead of inflation.
*If you have a person ‘A’ offering you 10,000$ and a person ‘B’ offers you 20,000$. The opportunity cost for choosing person A’s offer is 10,000$ (20,000-10,000) and the opportunity cost for choosing person B’s offer is -10,000$(10,000-20,000). Thus, choosing person B’s offer is the most logical.