In fact, don’t put all your money into any single investment. I’m not anti-bonds, I’m pro-diversification.

As the Fed has continued to hike interest rates, I’ve been encountering a lot of chatter about buying bonds, and while I agree with some of it I’ve also seen talk saying that anyone with money in stocks is a moron and that everyone should sell everything they own and put it all into long-term government bonds. The benefits of government bonds are clear: they are a risk-free way to protect and sometimes grow your money. A bond is just a loan to the government and the government (whether the Federal government of America or the AA+ rated governments of Europe and the rest of the world) is not going to go bankrupt. Governments like Germany, America, and Japan will always pay their debts so purchasing a government bond is guaranteed to return your money to you at the end of the day. But just because they don’t have risk doesn’t mean they don’t have cost.

Everything in economics has an opportunity cost and this applies especially to bonds. There’s no guarantee that the investment you made was the best way you could have invested your money, even if you made a bit of money through it in the long run. Let me explain some of the opportunity costs you are facing when you buy bonds.

If you buy bonds today, you lock in a fixed interest rate for the length of the bond (let’s ignore I-bonds for now). That means you will receive a fixed amount of money for the length of the bond, plus you will be given back the initial amount you paid at the bond’s maturity. So if you buy a 10,000$ bond, and hold it to maturity, you will have made 10,000$ + 4% interest, it sounds like a great deal. But what other opportunities did you have with your money? Well in December the Fed will have another meeting, and it’s possible that they will once again raise interest rates. If that happens, you could buy a bond with around 4.75% interest instead of around 4%, so one of the opportunity costs you have is that if you just waited another month you could have bought a higher yield 10,000$ bond and made more money.

That’s not the only opportunity cost though, what if you suddenly have to make a big purchase? You could sell that 10,000$ 4% bond you purchased, it’s still worth somewhere close to 10,000$ if you bought it recently, but if you sell it after the Fed has raised interest rates you will find the price you can get for it is much lower than what you may have expected. That’s because your bond is paying a lower interest rate than what people can get buying new bonds, why spend 10,000$ to buy a 4% bond when you can spend 10,000$ to buy a 4.75% bond. So if you buy a lot of bonds then have to sell them after an interest rate hike, you’ll have lost out compared to if you had bought after the interest rate hike or if you had not bought at all.

Another scenario is that the Fed doesn’t hike interest rates but the markets recover. Say the inflation report comes out and shows inflation slowing substantially, in that case the Fed would have less reason to raise rates and the markets would have more reason to rally as people expect better times ahead. You’ve still got your 4% bond but markets on average rise 7% each year, so in an average year the stock market can be expected to give greater returns than buying a bond. In this case you haven’t lost any money but you’ve incurred an opportunity cost by buying bonds instead of stocks, you could have had greater returns buying stocks.

I’m not saying don’t buy bonds, bonds can be a good way to mitigate risk and ensure consistent returns. But I am seeing some people act like current trends will last forever, that the market will stay down forever and thus bonds are the only way to get any kind of return. I’m just saying that every action has an opportunity cost, and while buying bonds are low risk they are still a bet that interest rates won’t go much higher and the market won’t gain too much. Otherwise, you might have been better off putting your money elsewhere.