Risks and Benefits of Treasury Bonds


As a form of Treasury security, a bond is a debt obligation issued and backed with the full faith and credit of the United States government. Think of it as the President handing you an I.O.U. Treasury bonds are sold in denominations of $1,000 and sold at coupon, meaning you receive interest payments semi-annually, the rate of which is fixed at the time of maturity — typically 30 years.

According to Fidelity Investments, new bonds are auctioned for original issue in February, May, August and November, or on the secondary market.

Does this sound like a type of investment you may want to try? Let’s thoroughly consider its advantages and disadvantages:

As a form of Treasury security, a bond is a debt obligation issued and backed with the full faith and credit of the United States government. Reasons to Consider Treasury Bonds

  • Credit quality — The federal government’s taxing power and our economy’s relative strength mean Treasury securities are considered to be of high credit quality.
  • Tax advantages — Interest earned off Treasury bonds is exempt from state and local income taxes (although subject to federal taxation).
  • Liquidity — Because so many Treasuries are bought and sold throughout the day by a wide range of investors — institutions, foreign governments, etc. — they are considered highly liquid. On most occasions, spreads, or the difference in price between the bid and offer, are among the most narrow available in the bond market, Fidelity noted.

 Risks Involved with Treasury Bonds

  • Lower yields—Less interest is paid by Treasury securities compared to other types of bonds because there is less credit or default risk. It’s a trade-off many investors are willing to live with.
  • Credit or default risk—Despite that level of risk being low, it does still exist, as it does in all bonds. “Investors should monitor current events, as well as the ratio of national debt to gross domestic product, Treasury yields, credit ratings, and the weaknesses of the dollar for signs that default risk may be rising,” according to Fidelity.
  • Interest rate instability— Interest rates of Treasuries are very susceptible to fluctuations, with the degree of volatility increasing with the amount of time until security. Not surprisingly, prices typically decline as rates rise.
  • Call risk — Some Treasury securities carry call provisions that allow the bonds to be retired prior to maturity. This usually occurs when rates fall drastically.
  • Inflation risk — Due to the relative low yields of Treasuries, sometimes the income produced is lower than the rate of inflation.

Now do these disadvantages outweigh the benefits of Treasury bonds? That’s a question only you can answer, with the help of a trusted financial advisor. An advisor can not only give you more information to aid in making your decision, but also update you on auction dates, secondary market availability and much more.

 

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