What happens to Bonds during inflation?

[TommyVercetti]

Totally hypothetical situation, I am just making up numbers. Say I bought a Bond which will mature in 20 years at $100,000. I paid $25,000 for it in 2003. I expect to cash it in 2023. Well 2023 comes along, and due to inflation, $100,000 is nothing at all, it is of even lesser value then $25,000 in 2003. So basically I just made a bad investment?

I know there are countries where there was sudden inflation (Venezuela ??), so all people who bought bonds got screwed?

 

[gopunk]

yup

that's a large reason why inflation sucks

 

[AccruedExpenditure]

They are worth less... you need interest to outrun inflation for long term bonds to be attractive

 

[AccruedExpenditure]

In Argentina (im sure you're talking about Argentina, not Venezuela ) the common people probably didn't buy bonds, it was foreign investors. Inflation within the country didn't hurt the foreign investors but the government defaulting on the payments due to inflation did.

 

[Buttzilla]

i used to work at a bank. had some guy come in and cashed all his bonds over the last 20 years...he bought 2 each month for about 500. but turns out, it was such a waste of money. not only cause of inflation but the money could've been better spend during those 20 years in other investments such as property. 25k in 1983 could've bought you a pretty nice house in the bay. now, it'll run about a few hundred thousands. another example, i just talked to my neighbor, said he bought his house for 30k 25 years ago, now its worth over 500k.

 

[TommyVercetti]

So how do banks combat inflation in car loans? Say I get a loan for 7% for 4 years. Inflation every year is 2%, so the bank is only making ~5%?

 

[ElFenix]

Originally posted by: TommyVercetti
So how do banks combat inflation in car loans? Say I get a loan for 7% for 4 years. Inflation every year is 2%, so the bank is only making ~5%?

yes, the bank is making 5%. thats about standard for a loan to someone with good credit.

 

[ElFenix]

the reason people invest in bonds is because they are at least somewhat risk-avoiding. stocks have a much higher payoff rate but also you could lose quite a bit of money, due to volatility (the natural up and down swing of the market). given the fact that over any 15 year period you choose the stock market has always been up quite a bit more than bonds over the same period, you'd almost have to be pretty risk-averse. so an economist one day took a look at the combined returns of the DJIA from 1900 forward, and the combined return of bonds from the same point, and came up with this illustration for how risk averse one would have to be to buy bonds:

say you had $2000. this is all the money you have. you have a choice: you can either take a 50/50 bet that your money will either increase by 50% or decrease by 50%; or you can pay to not take the bet. so if you take the bet, you have a 50% chance of landing $1000 extra and a 50% chance of costing $1000. its a fair bet, your expected payout is $0.

now, most people are somewhat risk-averse when it comes to their money, so they'll pay some money to keep from taking the bet. $100, $200, even $500. all pretty reasonable. well, people who would invest in bonds over stocks have a risk averseness of someone paying ~$980 to keep from taking the bet. that is, they would rather have $1020 than take a bet that would leave them with $1000 or $3000.

moral of the story: put all your money in an index fund

 

[Aceshigh]

If you wished you could buy I-bonds which are protected from inflation.