Financial analysts and the financial media often refer to U.S. Treasury bonds (T-bonds) as risk-free investments. And it's true. The United States government has never defaulted on a debt or missed a payment on a debt. You would have to envision the utter collapse of the government to find a scenario that would involve losing any of the principal invested in a T-bond.
Key Takeaways
- There is virtually zero risk that you will lose principal by investing in T-bonds.
- There is a risk that you could have earned better money elsewhere.
- Investing decisions are always a tradeoff between risk and reward.
The crucial word above is "principal." In investing, the safest investments have the lowest returns. And accepting a low return is in itself a risky decision.
Understanding U.S. Treasury Bond Risk
Most investments in debt, from corporate bonds to mortgage-backed securities, carry some degree of default risk. The investor accepts the risk that the borrower will be unable to keep up the interest payments or return the principal invested.
In the event of bankruptcy, bondholders are first in line before other investors, but that's no guarantee of full repayment.
This is not true for T-bonds, which are backed by "the full faith and credit" of the U.S. government. That means the Federal Reserve. Investors know that the Treasury Department will pay them back even if the Fed's balance sheet is ugly.
So, the risks to investing in T-bonds are opportunity risks. That is, the investor might have gotten a better return elsewhere, and only time will tell. The dangers lie in three areas: inflation, interest rate risk, and opportunity costs.
Inflation
Every economy experiences inflation from time to time, to one degree or another. T-bonds have a low yield, or return on investment. A little bit of inflation can erase that return, and a little more can effectively eat into your savings.
That is, an investment of $1,000 in a T-bond for one year at 1% interest would get you $1,010. But if inflation was 2%, the initial investment when it is returned will have the buying power of a little under $990.
Interest Rate Risk
When interest rates rise, the market value of debt securities tends to drop. This makes it difficult for the bond investor to sell a T-bond without losing on the investment.
Opportunity Costs
All financial decisions, even T-bond investments, carry opportunity costs.
An investor who purchases a $1,000 T-bond loses the chance to invest or spend that $1,000 elsewhere. The investor might have been better off putting $1,000 into an exchange-traded fund (ETF) that offered a greater potential for return along with a greater risk of principal loss. For that matter, the investor might have bought a new laptop for $1,000. If inflation continues at its current pace, that model will cost $1,025 a year from now.
FAQs
So, the risks to investing in T-bonds are opportunity risks. That is, the investor might have gotten a better return elsewhere, and only time will tell. The dangers lie in three areas: inflation, interest rate risk, and opportunity costs.
What are the risks of investing in Treasuries? ›
Treasury bonds are widely considered a risk-free investment because the U.S. government has never defaulted on its debt. However, investors should understand that even U.S. government bonds have interest rate risk. That is, if market interest rates rise, the prices of these bonds will fall, as they did throughout 2022.
What are the risks of investing in bonds? ›
Bonds are considered as a safe investment & also come with some risks which are Default Risk, Interest Rate Risk, Inflation Risk, Reinvestment Risk, Liquidity Risk, and Call Risk. Investors who like to take risks tend to make more money, but they might feel worried when the stock market goes down.
What are the two greatest risks for the owners of Treasury securities? ›
Like all guaranteed financial instruments, Treasuries are vulnerable to both inflation and changes in interest rates.
What is the disadvantage of investing in treasury bills? ›
This means that investors looking for high returns may not find T-bills attractive. Since T-bills have fixed interest rates, inflation can erode the purchasing power of the returns earned from these investments. This means that investors may need help to keep up with inflation, resulting in a decline in real returns.
Are Treasury bonds a high risk investment? ›
U.S. Treasury bonds are long-term debt securities. Treasury bonds mature in 20 or 30 years and pay interest every six months. When you purchase a Treasury bond, you are loaning money to the U.S. federal government. Treasury bonds are a low-risk investment that pays a fixed return and offers tax advantages.
What is the risk of long-term Treasuries? ›
The U.S. government has an excellent credit rating and repayment history, and is able to "print" money as necessary to service existing debt obligations. There are, however, other risks such as interest rate risk, the effects of inflation, and opportunity costs.
What is downside risk of a bond? ›
Downside risk is the potential for your investments to lose value in the short term. History shows that stock and bond markets generate positive results over time, but certain events can cause markets or specific investments you hold to drop in value.
What bonds are high risk? ›
High-yield bonds are debt securities, also known as junk bonds, that are issued by corporations. They can provide a higher yield than investment-grade bonds, but they are also riskier investments.
Are bonds a high or low-risk? ›
Higher yields enable individual bonds to once again play their traditional role as sources of reliable, low-risk income for investors who buy and hold them to maturity.
There is virtually zero risk that you will lose principal by investing in T-bonds. There is a risk that you could have earned better money elsewhere. Investing decisions are always a tradeoff between risk and reward.
Can you lose money on bonds if held to maturity? ›
After bonds are initially issued, their worth will fluctuate like a stock's would. If you're holding the bond to maturity, the fluctuations won't matter—your interest payments and face value won't change.
What are the three major risks when investing in bonds? ›
- Credit Risk — The risk that a bond's issuer will go into default before a bond reaches maturity.
- Market Risk — The risk that a bond's value will fluctuate with changing market conditions.
- Interest Rate Risk — The risk that a bond's price will fall with rising interest rates.
Government debt and the 10-year Treasury note, in particular, are considered among the safest investments. Its price often (but not always) moves inversely to the trend of the major stock market indexes. Central banks tend to lower interest rates in a recession, which reduces the coupon rate on new Treasurys.
What is the difference between Treasury bills and Treasury bonds? ›
Key takeaways. Treasury bills have short-term maturities and pay interest at maturity. Treasury notes have mid-range maturities and pay interest every 6 months. Treasury bonds have long maturities and pay interest every 6 months.
How do you avoid tax on Treasury bonds? ›
The Treasury gives you two options:
- Report interest each year and pay taxes on it annually.
- Defer reporting interest until you redeem the bonds or give up ownership of the bond and it's reissued or the bond is no longer earning interest because it's matured.
A Treasury investor could still lose money if they had to sell a Treasury prior to maturity, but the Treasury market is a much more liquid market than the CD market and therefore much easier to sell if needed.
Can you lose money investing in US Treasuries? ›
Key Takeaways. There is virtually zero risk that you will lose principal by investing in T-bonds. There is a risk that you could have earned better money elsewhere. Investing decisions are always a tradeoff between risk and reward.
What are the disadvantages of Treasury stock? ›
What are the Limitations of Treasury Stock?
- No voting rights.
- Not entitled to receive dividends.
- Not included in the calculation of outstanding shares.
- Do not exercise preemptive rights as a shareholder.
- Not entitled to receive net assets in case the company liquidates.
Ask any financial planner or Wall Street type and they'll tell you U.S. Treasury bonds are the “safest” asset you can own. In the halls of the financial establishment, the yield, or interest rate, on 10-year Treasurys is defined, literally as well as figuratively, as the “risk-free rate” of return.
