BERKELEY HEIGHTS, N.J. ( TheStreet) -- Recent market volatility has investors heading out of equities and into so-called safe investments such as 10-year U.S. Treasuries. Operation Twist by the Federal Reserve has dropped 10-year treasury yields below 2%. As I write this, the yield on 10-year Treasuries is a meager 1.88%.
For many investors that sounds great, given current equity market turbulence. Risk-averse investors often fail to account for inflation, though.
|Your 10-year Treasuries aren't as safe as you think -- while your money is locked up, inflation is stealing it away.|
Assuming a 3% inflation rate and a 1.88% 10-year treasury yield, investors are getting a negative real return of -1.09% per year. And if the investor needs to sell before the maturity they are likely to take a principal loss due to rising interest rates.
Negative real returns are bad because they result in a loss of buying power. For example, assuming 3% annual inflation, $100 in 10-years will buy only $76 of goods and services. The $100 really needs to grow at 3% just to keep up with inflation.So what investment historically has best kept up with inflation? That's right, the answer is good old equities. The chart below illustrates the historical long-term real return from 1926 to 2008:
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