Reaching for Yield: Lessons from the Past

Trevino, Ruben; Yates, Barbara
February 2006
Journal of Financial Planning;Feb2006, Vol. 19 Issue 2, p70
Academic Journal
• This study examines the question of when it might be advisable to switch from money market instruments (such as Treasury bills) to the typically higher-yielding short-term bonds. Specifically, the study tests whether current yield levels and current yield spreads are useful in predicting subsequent differences in one-year returns between investing in five-year T-bonds and three-month T-bills. • Using the period of 1954 to 2003, the study finds that while the prior yield level is not consistently related to the relative performance of short-term T-bonds compared with T-bills, the size of the prior yield spread does predict the odds of short-term T-bond returns outperforming T-bill returns. • When the spread is positive and greater than 200 basis points, there is a 70 percent chance that short-term T-bond returns will be higher than T-bill returns. • When the yield spread is negative (inverted yield curve), the odds are clearly in favor of T-bills; there is a 75 percent chance that T-bill returns will be higher than short-term T-bond returns. • For spreads between 0 and 200 basis points, the odds are 50-50 that short-term T-bonds or T-bills will provide higher returns. • The historical evidence also suggests that the reason spreads can predict relative performance between short-term T-bonds and T-bills is because they anticipate, to some extent, future changes in interest rates. INSET: Executive Summary.


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