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By Timothy Strauts | 03-05-2014 03:00 PM

Morningstar Minute: Inflation, Not Rising Rates, a Concern

Near-term inflation expectations are low, but fixed-income investors cannot overlook the negative impact inflation has on long-run returns.

The Morningstar Minute is our quick take on investments, the market, economic indicators, and more. Join us every day for fresh insights from our analyst team.

Tim Strauts: Bond investors today are very concerned about rising rates, but what they should really be concerned about is inflation.

As you can see in the chart here, we look at the total returns of investment-grade government bonds, which are five-year Treasuries, from 1926 to today. And $1 invested in 1926 grew to $93 today. Now, if you adjust that for inflation, that $1 would have only grown to $7, which is a pretty amazing difference in returns.

Now, in the second chart, you can see we highlighted a period of very high inflation, the 1970s, so from 1970 to 1980. And if you look at the returns of the government bond index, you would've actually had over a 100% return over that 10-year period. But when you adjust the returns for inflation, you would have actually lost money.

As you can see, inflation is obviously a very important factor to look at, and we're only seeing expected inflation of 1.5% to 2% for the foreseeable future. But investors should really keep an eye on this over the long term.

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