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.
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.
What are the key risks in the Treasury? ›
Within Corporate Treasury, the two most prominent areas of Risk Management are FX (foreign exchange) risk, which concerns foreign currency, and interest rate risk, which concerns the cost of borrowing. These two areas do not comprise the entire field of Risk Management, however.
What are the risks of the Treasury money market? ›
Because they invest in fixed income securities, money market funds and ultra-short duration funds are subject to three main risks: interest rate risk, liquidity risk and credit risk.
Which is a disadvantage of investing in bonds? ›
Historically, bonds have provided lower long-term returns than stocks. Bond prices fall when interest rates go up. Long-term bonds, especially, suffer from price fluctuations as interest rates rise and fall.
Does bonds have a high-risk? ›
Bonds in general are considered less risky than stocks for several reasons: Bonds carry the promise of their issuer to return the face value of the security to the holder at maturity; stocks have no such promise from their issuer.
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.
Therefore, bonds with longer maturities generally have higher interest rate risk than similar bonds with shorter maturities. to compensate investors for this interest rate risk, long-term bonds generally offer higher coupon rates than short-term bonds of the same credit quality.
Why not buy government bonds? ›
Fixed-rate government bonds can have interest rate risk, which occurs when interest rates are rising and investors are holding lower paying fixed-rate bonds as compared to the market.
What type of risk is the primary responsibility of Treasury? ›
Indeed, liquidity risk management is arguably one of the most important functions of the treasury department.
What is the risk of investing in Treasuries? ›
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.
Why people don t invest in Treasury bill? ›
Taxes: Treasury bills are exempt from state and local taxes but still subject to federal income taxes. That makes them less attractive holdings for taxable accounts. Investors in higher tax brackets might want to consider short-term municipal securities instead.
What are the disadvantages of Treasury I bonds? ›
One main limitation is that these bonds cannot be bought or sold on the secondary market. This means that once you purchase an I Bond, you are committed to holding it until maturity or redeeming it with the Treasury, subject to certain restrictions. Another potential downside is the purchase limit.
Can you lose money investing in Treasuries? ›
Although a Treasury bond can be sold before its maturity, the investor may take a gain or loss, depending on the bond's price in the secondary market at the time of the sale.
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.
A Treasury bill, or T-bill, is a short-term debt obligation backed by the U.S. Treasury Department. It's one of the safest places you can save your cash, as it's backed by the full faith and credit of the government. T-bills are auctioned off at a discount and then redeemed at maturity for the full amount.
Are Treasuries safer than cash? ›
Investors can choose which type of bonds to invest in based on their goals and risk tolerance. In times of economic instability, bonds and other debt instruments issued by the U.S. Treasury are considered extremely safe because the risk of the U.S. government defaulting on its financial obligations is minimal.
