Government Bonds – Are They Good Investment?
Government bonds: instead of asking money from the government, the government saves the money from you. After an agreed upon amount of time called a maturity date, they’ll return the money lent.
This type of bond gives the government a commitment to pay period interest payments known as coupon payments. Coupons represent semiannual interest payments on top of principal payments at maturity.
Since government bonds are considered risk-free, they also offer little to no return. Essentially, the government mostly acts as a piggy bank until a deadline, which could range from 10 to 30 years.
How Risk-Free is Risk-Free?
Government bonds can be reliable in different ways. Three factors affect the value of a bond before and during maturity dates: interest rates, inflation, and currencies.
- Rising interest rates on opportunity cost.
- Inflation rising above coupon rates.
- Index-linked bonds can help neutralize the risk.
- Fluctuating exchange rates (only when buying bonds that pays out in a different currency).
The government bonds you should take depend on which risk you’re going to take between the three of them.
US government bonds, called treasuries, are risk-free in credit risk. As the strongest economy, treasuries are considered as one of the world’s safest in terms of interest and principal payments.
American investors can fully expect to get their payments back on time.
Treasuries, while credit risk-free, are subject to interest rate risks. Every movement in interest rates will affect the value of your bond.
A bond’s longevity depends on the US Federal Reserve’s expectations on inflation rates. Rising rates lead to devaluing, while falling inflation rates can give a positive effect instead.
In the US, treasuries’ maturities are measured in three broad categories:
Treasury bills mature in a year or less. These are sold at a discount from their face value, but you’ll get a full amount once it matures.
Treasury notes have maturities from two to ten years. These are sold at face value but come with fixed interest rate, then will kick off interest payments every six months.
Treasury bonds have maturities of ten to thirty years. These earn interest until maturity with a payment par amount the equal to the principal.
Savings Government Bonds
The Treasury Department also issues inflation-linked savings bonds, which spares investors from inflation. I-bonds can’t be sold or traded, only redeemed after at least five years to prevent penalties.
I-bonds are tied to consumer price indexes instead of PCE inflation, which the US Federal Reserve prefers to tinker.
The opposite of Treasury Inflation-Protected Securities, or TIPS, are treasuries that protect investors from rising prices measured by the Consumer Price Index.
Series EE Bonds
These bonds are non-marketable, interest-bearing bonds that guarantee principals to double in value at maturity.
Considered ultra-safe with low risk, these bonds are only subject to federal taxes on maturity years.
How to Get Started with Government Bonds
A government usually issues bonds via auctions where large banks and financial institutions will gather to buy them. These institutions will sell these bonds to individual investors, banks, and pension funds.
Alternatively, government bond ETFs can track the prices of fixed-income securities that offer benefits of government bonds. These have additional liquidity and transparency.
There might be a lot to think about, but treasuries’ effectiveness is safest when you start it early. You may not get much return from the investment; you can still retrieve your lent money upon maturity.
So, How Expensive Can Government bonds Get?
Different governments dictate supply for government bonds and will only issue them when needed. As the acting investor looking to diversify a portfolio, governments will dictate whether the bond is an attractive investment.
Stock affects demand, especially when significant economic events are happening in the country. When economic problems emerge, investors flock over the safety of bonds.
Interest rates also influence discount rates, which dominoes into bond pricing. Higher inflation means higher interest rates, then requires higher discount rates, which decreases the bond’s price.
Longer-term bonds face inflation for a longer period of time, which makes them more vulnerable to lower pricing. Investors might get a lower return at maturity.
Falling interest rates, on the other hand, can cause bond yields to fall. This increases a bond’s price.
Low-risk investments like government bonds are likely to default on low loan payments. A riskier bond will trade at a lower price than the opposite.
To find out more about credit ratings, look through the three main credit rating agencies: Standard and Poor’s, Moody’s, and Fitch.