Why Choose Lower Return Over Higher Return?

By Justin May, Portfolio Manager

When you buy a stock, there’s no telling how much you’ll earn per year on your investment. Bonds are different. They are basically loans. For example, you might give the U.S. government $10,000, and in return they promise to pay you $400 (4%) in interest every year for 5 years, then at the end of 5 years they promise to give you your initial $10,000 back. Unlike a stock, the expected return on your investment in a bond is clear when the transaction is made.

Not all bonds promise to pay the same amount of interest every year. Some may promise 4% per year, while others promise much higher rates, sometimes over 10%. Bonds with high stated interest payments are issued by entities with a higher risk of bankruptcy. They offer that rate because investors won’t accept less.

Investors face a choice: accept a lower return from an entity with a low risk of failure (like a government), or a higher return from an entity which may go bankrupt before the loan is repaid. The latter is often referred to as a “high yield” bond.

It's tempting to take the higher return; some investors do. And on average, those who invest in high yield bonds are rewarded. Over the last 10 years, intermediate term high yield bonds have returned 4.7% per year, while government bonds with similar maturities have returned only 1.5%.

Because we recommend long-term investments, you might think we prefer high yield bonds because of their higher expected return.

We don’t. Here’s why. Below is a chart showing how high yield bonds performed during the 2008 financial crisis:

Chart comparing high yield bonds, government bonds, and S&P 500 performance in 2008

High yield bonds and stocks behaved the exact same way as panic set in. In just 6 months, the S&P 500 lost 36% of its value, while high yield bonds declined 32%. Equivalent government bonds rose by 6%.

We recommend bonds for liquidity and stability as stocks decline. High yield bonds move in sync with stocks when markets crash, so they’re of little interest to us. Compared to those who chose safer bonds, investors holding high yield bonds in 2008 experienced much greater losses and missed out on rebalancing opportunities because their bonds crashed with their stocks. By contrast, investors holding high-quality bonds sold some of those bonds at attractive prices to buy stock at low prices.

Over the last 10 years, high yield bonds returned 4.7%, while government bonds only returned 1.5%. But the S&P 500 returned 12.3%. If you’re going to take risks in your portfolio, we recommend you do so through long-term investment in stocks. They will likely outperform all other asset classes, high yield bonds included. Pay close attention to how much you allocate to stock (see this blog). With the amount you allocate to bonds, don’t be tempted by the flashy returns of risky high yield bonds; make sure your ‘safe’ money will be there when you need it.

Data sources:

High yield bonds represented by the Bloomberg U.S. High Yield Bond Index Intermediate. Data provided by Bloomberg Finance L.P. and accessed via Dimensional Returns Web 5/15/25. End date for data referenced is 4/30/25.
Government bonds represented by the Bloomberg U.S. Government Bond Index Intermediate. Data provided by Bloomberg Finance L.P. and accessed via Dimensional Returns Web 5/15/25. End date for data referenced is 4/30/25.
S&P 500 Index data provided by Ibbotson and accessed via Dimensional Returns Wed 5/15/25. End date for data referenced is 4/30/25.