Advantage: Low risk of default
Because Treasury bonds are backed by the U.S. government and have a high credit quality, most investment experts consider them a no-risk option. “Treasury bonds are considered risk-free assets, meaning there is no risk the investor will lose their principal,” explains the Investopedia team.
Treasury bonds’ long-term reliability make them a wise method of saving for retirement and are better at weathering the storm of market turbulence. Because of that, Treasury bonds can provide a steady source of secondary income — especially after you retire.
Disadvantage: Potential default
While Treasury bonds have historically proven to be safe investments, there’s always a chance they’ll face risks of early calls or defaults. Even these bonds aren’t entirely exempt from the effects of political unrest that could affect your investment before its target maturity date. “If you are a serious investor,” advises Baruch Mann, writing for The Smart Investor, “you should monitor current financial and political events … that may indicate a default risk is imminent.”
Advantage: High liquidity
While there are advantages to keeping your Treasury bond until its maturity date, you have the flexibility of selling it early on the secondary bond market when you deem necessary. The Motley Fool states it’s easy to buy or sell Treasury bonds, notes, or bills thanks to this active secondary market. Just be aware you may incur penalties for offloading bonds before their maturity date.
Advantage: Clear interest
When you buy a Treasury bond, you know upfront what its interest rate will be, and that rate will be locked in until the maturity date. This transparency lets you monitor the current interest rate and purchase Treasury bonds when they reach a high rate. And you won’t have to endure the uncertainty of variable interest rates during ownership that you do with other forms of investment.
Disadvantage: Low payouts
Riskier forms of investments can yield huge payoffs if you’re lucky. Treasury bonds, however, deliver low returns because of their low risk. Even a Treasury bond that reaches maturity will bring limited returns. Other types of investments — including corporate bonds and equities that pay dividends — can offer higher earning potential for the same principal investment.
Disadvantage: Interest rate and inflation changes
The biggest threats to your Treasury bond’s value are interest rate changes and rising inflation, which can hinder the profitability of your investment over time. “If interest rates are rising in an economy,” explains the Investopedia team, “the existing T-bond and its fixed interest rate may underperform newly issued bonds, which would pay a higher interest rate.”
Treasury bonds with low payout rates and long-term maturity are also susceptible to falling behind a rising inflation rate. If you don’t have Treasury Inflation-Protected Securities that adjust based on inflation, your bond may be locked at a deficient rate.
Advantage: Tax exemption
Unlike other forms of investment income, you typically don’t have to pay state and local income taxes on interest income from Treasury bonds. Mann points out there are certain scenarios in which you may have to pay capital gains taxes on these bonds, but in most circumstances, they’re deemed a different type of income.
This low risk makes Treasury bonds a great inclusion in your investment portfolio as a source of diversifications to offset riskier stock investments. Just make sure you consider all of the potential risks and limitations of this method before buying in.