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
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. If you're interested in investing in Treasury bonds or have other questions about your portfolio, consider speaking with a financial advisor.
What is the downside to buying Treasury bonds? ›
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.
What are the disadvantages of Treasury I bonds? ›
Key Points. Pros: I bonds come with a high interest rate during inflationary periods, they're low-risk, and they help protect against inflation. Cons: Rates are variable, there's a lockup period and early withdrawal penalty, and there's a limit to how much you can invest.
What is the disadvantage of investing in treasury bills? ›
T-bills are issued with maturities of only a few weeks to a few months. This means that investors looking for longer-term investments may need alternative options. If interest rates rise, the value of T-bills will decline, resulting in a potential loss for investors who need to sell their holdings before maturity.
Is there a high risk for investing money in U.S. Treasury bills? ›
While interest rates and inflation can affect Treasury bill rates, they're generally considered a lower-risk (but lower-reward) investment than other debt securities. Treasury bills are backed by the full faith and credit of the U.S. government. If held to maturity, T-bills are considered virtually risk-free.
Do you pay taxes on Treasury bonds? ›
Interest from Treasuries is generally taxable at the federal level, but not at the state level. Interest from munis is generally exempt from federal taxes, and if you live in the state where the bond was issued, the interest may also be exempt from state taxes.
Is it better to buy 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.
Can Treasury bonds lose value? ›
Treasury bonds are considered safer than corporate bonds—you're practically guaranteed not to lose money—but there are other potential risks to be aware of. These stable investments aren't known for their high returns. Gains can be further diminished by inflation and changing interest rates.
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.
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 |
The biggest downside of investing in T-bills is that you're going to get a lower rate of return compared to other investments, such as certificates of deposit, money market funds, corporate bonds or stocks. If you're looking to make some serious gains in your portfolio, T-bills aren't going to cut it.
What is the downside to Treasuries? ›
Those who sell their bonds before maturity during a period of rising interest rates may receive less than the bond's face value, incurring a loss. Inflation risk: Inflation erodes the purchasing power of the fixed interest payments from bonds over time.
Why would anyone bother investing in Treasury bills? ›
Treasury securities are considered the safest and most liquid investment. This makes Treasuries the perfect collateral for borrowing money.
Can you lose money investing in Treasury bills? ›
The Bottom Line. Treasury Bills, or T-bills, represent short-term debt obligations by the Treasury. Because the U.S. government backs them, they are considered extremely low-risk, although they also have relatively low returns. TreasuryDirect.
What is the difference between a Treasury bill and a Treasury bond? ›
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.
Do you pay capital gains on Treasury bonds? ›
Are all bonds taxed? Bonds are divided into two classes: taxable and tax-exempt. A bond's tax-exempt status applies only to the bond's interest income. Any capital gains generated from selling a bond or bond fund before its maturity date is taxable, regardless of the type of bond.
Is it a good idea to invest in Treasury I bonds? ›
The pros of investing in I-bonds
In fact, I-bonds often outperform many of the highest-performing stocks as well during inflationary periods. These Treasury-issued bonds generate high returns without all the risks of those other high-yielding investments because they're backed by the U.S. government.
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 time to buy Treasury bonds? ›
This time has been different: The 10-year Treasury yield has been hovering in a range above where it was when the Fed last hiked in July 2023. We believe the historical relationship should hold and we expect the 10-year Treasury ultimately to decline modestly from current levels as growth and inflation slow.
