For any debt obligation to be considered completely risk-free, investors must have full faith that the principal and interest will be paid in full and in a timely manner. The faith aspect of a debt obligation is measured by a country's credit rating. Much like an individual's credit rating is determined by his or her borrowing and repayment history, so too are governments' financial histories scrutinized. From time to time, governments will borrow funds from other countries and investors through loans and bonds.
The servicing and repayment of these bonds are carefully measured by financial institutions for creditworthiness. Specifically, these financial institutions look at a government's lending and repayment history, the level of outstanding debt and the strength of its economy.
U.S. Treasury bonds(T-bonds) are often touted as risk-free investments. And it's true. You would have to envision the utter collapse of the government and society 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 long-term U.S. government bonds.
- 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.
Government Debt and Credit Ratings
One of the most popular credit rating companies, Standard and Poor's, has given the U.S. government its second highest possible rating: AA+. Because U.S. government bonds are backed by the U.S. government and the U.S. has the most powerful economy in the world, these bonds are widely considered to be risk-free. When you purchase this type of bond, the U.S. government is guaranteeing that the interest and principal will be paid according to the bond covenants. That is, they are guaranteeing that payments will be paid on time and in full.
Some economists point to the 25% rule which states that any long-term debt that exceeds 25% of the annual budget is excessive. Other economists do not share this view.
Only a monumental downturn in the economy or, possibly, a very rare circ*mstance during a time of war would prevent the U.S. government from repaying its short- or long-term debts. However, even such events are unlikely to result in the U.S. government defaulting, since it has the ability to print additional money (monetary policy) or increase taxes (fiscal policy) if additional capital is needed.
The United States government has never defaulted on a debt or missed a payment on a debt.
Advisor Insight
Peter J. Creedon, CFP®, ChFC®, CLU®
Crystal Brook Advisors, New York, NY
Many people consider U.S. government bonds as “risk-free” because there is a very slim perceived chance that the country will default.
In my opinion, interest rate risk is currently the greater concern. The coupon payments the U.S. government will pay you is fixed at issuance, but the markets may create volatility for the issue that will cause the bond price (principal) to rise and fall during the life (term) of the bond. If the market interest rate fluctuates while your coupon is fixed, this may cause your investment to change in value. Also, if you choose to sell your bond before maturity you may experience a decline of principal.
Like all investments, risk is an integral part of the process. Invest with knowledge, so you know what your risks are and their effects on your capital.
FAQs
Key Takeaways. There is virtually zero risk that you will lose principal by investing in long-term U.S. government bonds.
Are long-term U.S. government bonds risk free? ›
They offer a fixed interest rate and are backed by the U.S. government, making them a low-risk investment. While they may not yield the highest returns compared to riskier investments, they can provide stability to your portfolio, particularly during times of market volatility.
How safe are U.S. government bonds? ›
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.
How risky are long-term bonds? ›
There are two primary reasons why long-term bonds are subject to greater interest rate risk than short-term bonds: There is a greater probability that interest rates will rise (and thus negatively affect a bond's market price) within a longer time period than within a shorter period.
Is it true that US treasury security is risk free? ›
U.S. treasury security is not strictly risk free. Though U.S. treasury securities are regarded as free from default risks, they are subject to various other risks: inflation risk: that rise in inflation reduces the real return on these bonds.
Why government bonds are not risk-free? ›
Credit ratings
Government bonds are usually viewed as low-risk investments, because the likelihood of a government defaulting on its loan payment tends to be low. But defaults can still happen, and a riskier bond will usually trade at a lower price than a bond with lower risk and a similar interest rate.
Why are U.S. government bonds low-risk? ›
GOVERNMENT BONDS
Intermediate-term bonds mature in three to 10 years, whereas long-term bonds generally mature in 10 to 30 years. Risk Considerations: Among the lowest risk of all bond investments, these bonds have low credit risk because they are backed by the full faith and credit of the U.S. government.
What is the safest government bond in the world? ›
The various types of bonds that are offered by the U.S. Treasury are considered to be among the safest in the world. Because of their relatively low risk, government bonds typically pay low interest rates.
What is the safest US bond? ›
Treasuries are generally considered"risk-free" since the federal government guarantees them and has never (yet) defaulted. These government bonds are often best for investors seeking a safe haven for their money, particularly during volatile market periods. They offer high liquidity due to an active secondary market.
Are government bonds safer than banks? ›
Bonds are considered a low-risk investment because the federal government fully backs them, not banks. They tend to be long-term investments and are considered a great way to diversify your investment portfolio.
We suggest investors consider high-quality, intermediate- or long-term bond investments rather than sitting in cash or other short-term bond investments. With the Fed likely to cut rates soon, we don't want investors caught off guard when the yields on short-term investments likely decline as well.
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.
Is it a good idea to buy bonds now? ›
Fed rate policy's impact on your investing
So what's the significance of tight Fed policy for your investments? Answer: Now may be the perfect time to invest in bonds. Yields are at levels you could only dream of 15 years ago, so you'd be locking in substantial, regular income.
Are bonds safe if the market crashes? ›
There is nothing that will definitely go up if the stock market crashes. Interest bearing investments such as money market funds will continue to earn interest. Bonds may hold their value or increase, and individual bonds including Treasury's will continue to earn interest.
Can you lose money buying US treasuries? ›
However, CDs and Treasuries are fixed income investments and subject to similar risks as other fixed income investments. For example, if interest rates rise, the price of a CD or Treasury will fall and if you need the investment prior to maturity and have to sell it, you may lose money.
Do US Treasury bonds have no financial risk? ›
U.S. Treasury bonds (T-bonds) are often touted as risk-free investments. And it's true. You would have to envision the utter collapse of the government and society to find a scenario that would involve losing any of the principal invested in a T-bond.
Is the risk free rate the 10 year U.S. Treasury bonds? ›
The 10 year treasury yield is included on the longer end of the yield curve. Many analysts will use the 10 year yield as the "risk free" rate when valuing the markets or an individual security.
What type of bonds does the US government sell that are risk free? ›
Treasury bonds, notes, and bills have no default risk since the U.S. government guarantees them. Investors will receive the bond's face value if they hold it to maturity. However, if sold before maturity, your gain or loss depends on the difference between the initial price and what you sold the Treasury for.
What is a major disadvantage of purchasing U.S. 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.
