Pretty soon we'll have the data for the 120th run of my Big Government Funds study.

But I'll jump the gun and let you know the results after 119 data runs because, well, another month isn't going to change anything.

The news? In all but 16 of the 119 five-year periods I have run this study, the simple purchase of a 5-year Treasury obligation did better than an index of major government bond funds. Purchase of a 5-year Treasury beat the index 86.6 percent of the time.

This is very important information for retirees due to the way I measure performance. While most studies of fund performance assume that all income is reinvested and measure the accumulation over a period of time, my study assumes that you are living like a retiree. You take your investment income and spend it. You hope that your principal will be intact at the end of the period. If your original principal is lower at the end of the investment period, the income you received is adjusted downward to reflect the loss.

The table below, for instance, shows what would have happened if you had invested $10,000 in a 5-year Treasury in November 1997. It was providing an annual yield of 5.80 percent. Over the 5 years ending in October you would have received $2,900 in interest income. At the end of the period you would have received your original $10,000 investment back.

If you had invested $10,000 in Fidelity Government Income Fund (ticker: FGOVX) at the same time and taken the income distributions, you would have received $2,831 in interest over the 5-year period, slightly less than the income from the 5-year Treasury. Your initial investment, however, would have appreciated to $10,680. This raises your return to 7.02 percent.

Similarly, if you had invested $10,000 in the worst performing fund over the period--- AXP Federal Income A shares--- you would have received only $2,438 in interest income over the period. Your original principal would be down to $9,557, largely due to the 4.75 percent front-end commission. Adjusting for the principal loss, your effective return on $10,000 is only $1,995 or 3.99 percent a year. (As a practical matter, it's really difficult to overcome the cost of an up-front commission on a bond fund.)

When you average the 19 funds presented in the table, the portfolio average trails the 5-year Treasury, as it has in 103 of the 119 times I have done this exercise.

Five Year Treasury Still Tops in Bond Bull Market
Table shows the end value of a $10,000 investment made at the beginning of November 1997 plus all interest income received during the five-year period compared to a 5-Year Treasury Note purchased at the same time. The last column adjusts the return to reflect capital gains or losses.
Fund Name End Value Total Income Excess over 10k Avg./ Year
  Fidelity Government Income





  Vanguard GNMA





  Vanguard Short-Trm Fed





  MSDW U.S. Govt Secs B





  Scudder GNMA AARP





  AmCent GNMA Inv





  Federated Govt Income Secs F





Dreyfus GNMA





5 Year Treasury: 11/97---5.80%





Portfolio Average





  Merrill Lynch US Govt. Mtg D





  Liberty Fed Securities A





  Franklin U.S. Govt Secs A  





  Lord Abbett U.S. Govt Secs A





  Liberty Int. Govt A





  Amer Funds U.S. Govt A





  Scudder U.S. Govt Secs A  





  Federated Fund for US Govt A





  Putnam American Govt Inc A





  Putnam U.S. Govt Income A  





  AXP Federal Income A





Source: Morningstar Principia, October 31, 2002 data. Yields for period come from "Selected Interest Rates", a Dallas Federal Reserve Bank document that can be downloaded as a PDF file.

Now think about cash income. Of the 19 funds, 11 produced less interest income than a 5-year Treasury. Of the 8 funds that produced more interest income than a 5-year Treasury, only 4 had an advantage greater than $100 over the 5-year period. That's $20 a year on a $10,000 investment.

Finally, remember that the last five years saw major interest rate declines. We haven't seen yields this low in a generation. We've been in a bull market for bonds. Yet, over the last 24 months and 24 repetitions of this study--- a period that marks one of the best bond markets in history--- the 5-year Treasury only trailed the fund index twice.

What does all this mean?

Here's my take:
  • Whether your nest egg is accumulating or distributing, avoid front-end loads on fixed income funds. Too much can happen in five years to pay up front fees.
  • If you are retired and spending your interest income, give serious thought to buying individual Treasury notes as part of your portfolio.
  • If you are accumulating or retired but willing to take some risk, investigate the funds that appear at the top of this list month after month: Fidelity Government Income, Vanguard GNMA, and American Century GNMA