Bond Interest Rates Are Sky High — Should You Abandon Stocks for Them Right Now?

The Federal Reserve (or Fed) is the country’s central bank, ultimately responsible for maintaining the financial system’s stability, implementing monetary policies, and regulating the financial industry. Part of accomplishing the first part is controlling inflation levels, which the Fed has focused on for the past two years.

One way to combat rising inflation is by raising interest rates. Ideally, higher interest rates make borrowing less attractive (because it’s more expensive), which slows down the amount of money in circulation and brings down prices.

Rising interest rates have a two-fold effect. On one end, debts become more expensive. On the other end, checking and savings accounts, bonds, and other fixed-income investments offer higher yields. With short-term yields hovering well over 5%, many people are considering abandoning stocks and jumping ship.

Here’s why that might not be the best route for long-term investors.

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Stocks offer higher upside than bonds

U.S. Treasury bonds are as risk-free of an investment as you’ll find. But while the idea of guaranteed returns is enticing, investors need to think beyond the short-term.

As it stands, you can get a one-year Treasury bond with a yield of around 5.4%, meaning a $10,000 investment could earn $540 in interest over that span. While 5.4% in risk-free interest is attractive, the growth ends when the bond’s term ends. You can do it all over again, but you’re at the mercy of whatever the interest rates are at the time.

Stocks offer the chance for much higher growth for as long as you hold onto them. Of course, nothing is guaranteed in the stock market, and you could lose money. But the upside typically outweighs the downside — especially if you’re investing in high-quality blue-chip stocks or broad indexes like the S&P 500.

The S&P 500, which tracks 500 of the largest companies by market cap, has historically averaged around 10% annual returns over the long run. For perspective, let’s see how $10,000 annual investments would shape up after five and 10 years, assuming gains are reinvested (and in the case of bonds, rebought).

Source: Author calculations. Total rounded down to the nearest hundred.

This is just a simple hypothetical, but it proves the overall point. While Treasury bonds offer a safe and guaranteed return, the potential for higher growth from stocks is attractive. Even a slight difference in annual returns can lead to a substantial gap in earnings over time.

Who bonds may make sense for

When you’re decades away from retirement, your goal should be to grow your money somewhat aggressively, typically by investing in stocks.

As you near retirement, however, you don’t want to stop trying to grow your money altogether, but you do want to begin shifting your focus to preserving your savings. That typically means decreasing your stake in stocks and increasing the amount of bonds and cash in your portfolio.

If you’re within a decade or so of retirement, you’re in a great position right now to be making good returns on any cash you may have sitting around (outside of your emergency fund). That can help provide a good balance of risk and reward.

Consider dividend stocks as an option

If you’re looking for guaranteed returns, don’t overlook dividend stocks. Investors can receive consistent and reliable income from dividend stocks, just like the interest earned from a Treasury bond. The biggest difference is that dividend stocks can give you the best of both worlds: They can grow in value while simultaneously providing reliable income.

Dividends are typically paid in cash each quarter, though you can reinvest dividends to buy more shares of the stock that paid it. Doing the latter can be a good way to increase the number of shares you own over time, thus generating even larger dividend payouts for you down the road.

There is a possibility that a company cancels its dividend for various reasons, but if you’re investing in well-established companies with strong balance sheets, you shouldn’t have to worry about that. Plenty of companies like Dividend Kings have decades-long histories of increasing their dividend payouts annually.

Take a company like Coca-Cola, which has increased its dividend for 61 consecutive years. It’s as safe as a dividend can get in the stock market. Nothing is 100% guaranteed, but you can sleep well at night knowing its track record.

Dividend stocks can be a good option regardless of what stage you’re at in your financial journey.