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
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 is the downside to buying Treasury bonds? ›
These are U.S. government bonds that offer a unique combination of safety and steady income. But while they are lauded for their security and reliability, potential drawbacks such as interest rate risk, low returns and inflation risk must be carefully considered.
What is the disadvantage of investing in treasury bills? ›
However, should interest rates rise, the existing T-bills fall out of favor since their return is less than the market. For this reason, T-bills have interest rate risk, which means there is a danger that bondholders might lose out should there be higher rates in the future.
What is the problem with Treasury bonds? ›
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 disadvantages of Treasury I bonds? ›
The initial yield is only good for the first six months you own the bond. After that, the investment acts like any other variable vehicle, meaning rates could go down and you have no control over it. And if you wait until, say, 2026 to buy an I bond, the initial rate could be well below current levels.
Do Treasury bonds ever lose value? ›
If a bond is held past its maturity, the federal government remains responsible for the debt. However, savings bonds that are held past their maturity date do not continue to earn interest and may actually lose value due to inflation.
Do you pay taxes on Treasury bonds? ›
Interest income from Treasury securities is subject to federal income tax but exempt from state and local taxes. Income from Treasury bills is paid at maturity and, thus, tax-reportable in the year in which it is received.
Are T-bills safe if the market crashes? ›
Treasury securities
They are backed by the full faith and credit of the U.S. government, making them the safest of all bond types.
Which is better, treasury bills or bonds? ›
Compared with Treasury notes and bills, Treasury bonds usually pay the highest interest rates because investors want more money to put aside for the longer term. For the same reason, their prices, when issued, go up and down more than the others.
What happens when Treasury bonds go down? ›
Bond prices move in inverse fashion to interest rates, reflecting an important bond investing consideration known as interest rate risk. If bond yields decline, the value of bonds already on the market move higher. If bond yields rise, existing bonds lose value.
U.S. Treasury bonds are fixed-income securities. They're considered low-risk investments and are generally risk-free when held to maturity. That's because Treasury bonds are issued with the full faith and credit of the federal government.
Can you lose money on bonds if held to maturity? ›
Holding bonds vs. trading bonds
However, you can also buy and sell bonds on the secondary market. 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 disadvantages of TreasuryDirect? ›
Securities purchased through TreasuryDirect cannot be sold in the secondary market before they mature. This lack of liquidity could be a disadvantage for investors who may need to access their investment capital before the securities' maturity.
Is buying Treasury I bonds a good investment? ›
I bonds are a safe investment backed by the U.S. government that protects against inflation with a combination of fixed and variable interest rates. While I bonds offer tax advantages and low minimum investment amounts, they have downsides, including a penalty for early redemption and fixed rates that can be low.
Is it safe to invest in Treasury bonds now? ›
Treasury securities are considered a safe and secure investment option because the full faith and credit of the U.S. government guarantees that interest and principal payments will be paid on time.
How much is a $100 savings bond worth after 30 years? ›
How to get the most value from your savings bonds
| Face Value | Purchase Amount | 30-Year Value (Purchased May 1990) |
|---|
| $50 Bond | $100 | $207.36 |
| $100 Bond | $200 | $414.72 |
| $500 Bond | $400 | $1,036.80 |
| $1,000 Bond | $800 | $2,073.60 |
