The Lowdown on Treasury Bonds
Happy Birthday America! Two hundred forty two years ago, the Founding Fathers of our country signed the Declaration of Independence, the first step to setting up a free and independent nation that we, of course, know at the United States of America.
Early on, the Founders knew they had to create a means of financing the federal government. Whether for building roads, utilities, public structures, and, of course, for a strong national defense, the newly approved US constitution authorized Congress to levy taxes for these projects, as well as to issue Treasury Bonds. As discussed in previous issues of God’s Good News Gazette, bonds are debt instrument, or I.O.U.’s. Thus, the US Government would issue bonds that investors would purchase in exchange for a modest rate of interest.
Now, to be clear, the US Treasury has a few instruments in its arsenal. First of all, there are Treasury Bills, which are very short term investments, typically 3 to 12 months. For those avid readers of this publication, you will remember that the shorter the term of investment the lower the interest rate. And, to the contrary, the longer the term of investment, the higher the rate of interest.
Then, there are Treasury Notes, which are debt instruments of 2 years to 10 years in duration. These pay a slightly higher interest rate than Treasury Bills. Lastly, there are Treasury Bonds, which are issued in 10 year to 30 year increments, which, as you may guess, pays the highest interest rate of the three.
Now, if you look at interest rates today, you will notice that Treasury Bills are paying well less than 1% interest. And, Treasury Bonds are paying over 3%. So, you can see that the interest rate is relatively low when compared with other types of investments. “So”, you ask, “why would someone invest in Treasury instruments with such a modest rate of interest?” The answer, quite simply, is for their safety.
Treasury instruments carry a AAA credit rating, which is the highest rating issue by any credit rating agency. History has shown that there has never been a default of a US Treasury instrument, which is very comforting to the “faint of heart” investors. But, history has also shown that interest rate have not always been this low. Back in 1979 and 1980, interest rates on these investments were upwards of 10%. Also, a study of rates on US government bonds over the past seventy or eighty years shows an average interest rate of between 4% and 5%.
While investors can take comfort in owning a Treasury Bill, or a shorter-term Treasury Note, in this current market, they need to be aware that the “real” rate of return, which factors in inflation, may close to zero, or even negative. One other factor to consider is that due to the great demand for these high quality investments, Treasury Bonds and Notes typically sell at a premium. This means you will pay more than the face value of the bond to own it.
So, is it a smart idea to buy US Treasury instruments? The answer, as usual, is “it depends on your objective.” I would suggest, of course, that you take all things into due consideration, and that you seek out a qualified Financial Advisor to assist you in your decision!