How Safe Are Treasury Bonds?

Conventional wisdom has long taught us that US Treasury Bonds are supposed to be some of the safest investments around. Yet this may not be the case there is a school of thought that holds the risks associated with these instruments are far greater than is popularly believed.

The Traditional Argument

The traditional argument for treasuries is that the US government will never out of business and always be there to pay off its bonds. The rest of the argument goes that the government can always print more money or raise taxes to meet its obligations. This argument is based on two assumptions: that the government will act rationally and meet its obligations. We have many more Investing Help Articles Now Available.

The problem with this train of thought is that governments will not always behave in a rational manner. If they did there would be no such thing as war and no need for a military. The other is that governments including the US government can default on obligations. This means some of the security associated with bonds may not exist.

During the summer of 2011 the US government came very close to default or not having enough money to pay off bonds and other obligations. The reason for this was that the Congress failed to reach an agreement on the debt ceiling for political reasons. The debt ceiling is the amount of money that Uncle Sam is allowed to borrow. As this example proves all governments are subject to politics and politicians rarely think about the economic consequences of their actions. There are also some political leaders who are willing to take any action including default to achieve their goals.

Treasury Bonds and Inflation

Treasury bonds pay a low rate of interest that is supposed to be close to the average in the bond market. The problem is that this rate is often so low that the return on the bonds can be less than the rate of inflation. In April 2012 the interest rate on a 30 bond ranged from 3.35{7bd3c7ad8bdfca6261de5ca927cd789e17dbb7ab504f10fcfc6fb045f62ae8d5} to 3.15{7bd3c7ad8bdfca6261de5ca927cd789e17dbb7ab504f10fcfc6fb045f62ae8d5}. Returns on a 20 year bond were worse ranging from 3{7bd3c7ad8bdfca6261de5ca927cd789e17dbb7ab504f10fcfc6fb045f62ae8d5} to 2.76{7bd3c7ad8bdfca6261de5ca927cd789e17dbb7ab504f10fcfc6fb045f62ae8d5}.

The problem with this is that the usual rate of inflation is around 3{7bd3c7ad8bdfca6261de5ca927cd789e17dbb7ab504f10fcfc6fb045f62ae8d5}, but it can range higher. If Steve bought a bond that paid 2.5{7bd3c7ad8bdfca6261de5ca927cd789e17dbb7ab504f10fcfc6fb045f62ae8d5} interest and the rate of inflation was around 3.5{7bd3c7ad8bdfca6261de5ca927cd789e17dbb7ab504f10fcfc6fb045f62ae8d5} he would lose 1{7bd3c7ad8bdfca6261de5ca927cd789e17dbb7ab504f10fcfc6fb045f62ae8d5} or 1 cent on the dollar annually. If Steve invested $10,000 in treasury bonds in one year he would $9,990 because of inflation. If the rate of inflation goes higher Steve can lose more.

There have been times in American history, such as the period right after World War II when the inflation rate has been well over 10{7bd3c7ad8bdfca6261de5ca927cd789e17dbb7ab504f10fcfc6fb045f62ae8d5}. A person holding treasury bonds back then could have lost 10{7bd3c7ad8bdfca6261de5ca927cd789e17dbb7ab504f10fcfc6fb045f62ae8d5} of the value of her investment. That of course is the worst case scenario but even an average rate of inflation can destroy bonds value.

Not a Good Long Term Investment

The moral of the story is that Treasury bonds are not a good long term investment nor are they a good retirement investment. The risk from inflation is simply too great. Persons investing long term will need something that pays a return greater than inflation.

Those planning for return need to look beyond treasury bonds. There are many other secure investments out there that offer a much better rate of return. We have many more Investing Help Articles Now Available.

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