For any debt obligation to be considered completely risk-free, investors must have full faith that the principal and interest will be paid in full and in a timely manner. The faith aspect of a debt obligation is measured by a country's credit rating. Much like an individual's credit rating is determined by his or her borrowing and repayment history, so too are governments' financial histories scrutinized. From time to time, governments will borrow funds from other countries and investors through loans and bonds.
The servicing and repayment of these bonds are carefully measured by financial institutions for creditworthiness. Specifically, these financial institutions look at a government's lending and repayment history, the level of outstanding debt and the strength of its economy.
U.S. Treasury bonds(T-bonds) are often touted as risk-free investments. And it's true. You would have to envision the utter collapse of the government and society 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 long-term U.S. government bonds.
- The U.S. government has an excellent credit rating and repayment history, and is able to "print" money as necessary to service existing debt obligations.
- There are, however, other risks such as interest rate risk, the effects of inflation, and opportunity costs.
Government Debt and Credit Ratings
One of the most popular credit rating companies, Standard and Poor's, has given the U.S. government its second highest possible rating: AA+. Because U.S. government bonds are backed by the U.S. government and the U.S. has the most powerful economy in the world, these bonds are widely considered to be risk-free. When you purchase this type of bond, the U.S. government is guaranteeing that the interest and principal will be paid according to the bond covenants. That is, they are guaranteeing that payments will be paid on time and in full.
Some economists point to the 25% rule which states that any long-term debt that exceeds 25% of the annual budget is excessive. Other economists do not share this view.
Only a monumental downturn in the economy or, possibly, a very rare circ*mstance during a time of war would prevent the U.S. government from repaying its short- or long-term debts. However, even such events are unlikely to result in the U.S. government defaulting, since it has the ability to print additional money (monetary policy) or increase taxes (fiscal policy) if additional capital is needed.
The United States government has never defaulted on a debt or missed a payment on a debt.
Advisor Insight
Peter J. Creedon, CFP®, ChFC®, CLU®
Crystal Brook Advisors, New York, NY
Many people consider U.S. government bonds as “risk-free” because there is a very slim perceived chance that the country will default.
In my opinion, interest rate risk is currently the greater concern. The coupon payments the U.S. government will pay you is fixed at issuance, but the markets may create volatility for the issue that will cause the bond price (principal) to rise and fall during the life (term) of the bond. If the market interest rate fluctuates while your coupon is fixed, this may cause your investment to change in value. Also, if you choose to sell your bond before maturity you may experience a decline of principal.
Like all investments, risk is an integral part of the process. Invest with knowledge, so you know what your risks are and their effects on your capital.
FAQs
There is virtually zero risk that you will lose principal by investing in long-term U.S. government bonds. The U.S. government has an excellent credit rating and repayment history, and is able to "print" money as necessary to service existing debt obligations.
Are government bonds the risk-free rate? ›
The yield curve for government bonds is also called the 'risk free yield curve'. The expression 'risk free' is used because governments are not expected to fail to pay back the borrowing they have done by issuing bonds in their own currency.
Are Treasury bills really risk-free? ›
T-bills are short-term U.S. debt securities. They are currently paying around 5% and are considered a risk-free investment if held to maturity.
How safe are US government bonds? ›
Bottom Line. Treasury bonds are viewed as a secure and stable investment option, offering a predictable income stream and serving as a hedge against market volatility, which can be particularly appealing to conservative investors and those with long-term financial goals.
Why are US treasury bonds not completely riskless? ›
Treasury bonds are not completely riskless, since their prices will decline when interest rates rise.
Can you lose money buying US treasuries? ›
Treasury bills can be a good investment depending on your financial goals and risk tolerance. They are considered one of the safest investments available, backed by the full faith and credit of the U.S. government--meaning that you are not likely to experience losses on your initial investment.
What bonds are considered risk-free? ›
A risk-free bond refers to a bond issued by an entity that's considered absolutely certain to pay back both its principal and interest, with no risk of default. Generally, bonds issued by governments of sovereign developed nations, such us U.S. Treasury bonds, are considered to be risk-free.
Which is safer Treasury bills or Treasury bonds? ›
Treasury bills function more like cash in your portfolio and can be a safe harbor during turbulent economic times. Treasury bonds can provide a dependable stream of income, but can suffer a loss of value on secondary markets if interest rates go up.
What is the safest government bond? ›
Treasury securities like T-bills and T-notes are very low-risk as they're issued and backed by the U.S. government. They provide a safe way to earn a return, albeit generally lower than aggressive investments.
Are long-term treasuries a good investment now? ›
“Intermediate and long-term Treasury yields are still near their highest levels in 15 years, so we'd rather lock in those high yields with certainty rather than risk reinvesting at lower yields once the Fed does begin to cut rates.”
You can lose money on a bond if you sell it before the maturity date for less than you paid or if the issuer defaults on their payments.
Are treasury bills safer than CDs? ›
Both CDs and Treasury bills are safe options that can help you grow your money faster. Which tool is better for you depends on your goals, how liquid you need your money to be, and time horizon.
Are treasuries safer than FDIC? ›
Both CDs and Treasuries are considered extremely safe investments. Treasuries are backed directly by the federal government, while CDs are covered by FDIC insurance – which is also backed by the federal government. In fact, no depositor has lost a penny of FDIC-insured funds since the FDIC was founded in 1933.
Can you lose money on bonds if held to maturity? ›
TAKEAWAYS: Not losing money by holding a bond until maturity is an illusion. The economic impact of market rate changes still impacts investors holding bonds until maturity. A bond index fund provides an investor with greater diversification and less risk.
What is the disadvantage of US Treasury bond? ›
The major drawback to Treasury securities is their low yield. "Interest rate risk is real," says Alexander Campbell, a registered investment adviser and accredited investment fiduciary with A.G. Campbell Advisory LLC.
What is the problem with Treasury bonds? ›
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.
Are government agency bonds risk-free? ›
Agency bonds are the debt securities issued by certain departments of the U.S. government, along with associated government-sponsored enterprises. Although they are not issued by the Treasury, these bonds typically have a low risk profile and are considered extremely safe investments.
Is a Treasury rate a risk-free rate? ›
As obligations of the U.S. government, Treasury securities are considered to be free of default risk. The market is therefore a benchmark for risk-free interest rates, which are used to forecast economic developments and to analyze securities in other markets that contain default risk.
Are fixed rate bonds risk-free? ›
A key risk of owning fixed rate bonds is interest rate risk or the chance that bond interest rates will rise, making an investor's existing bonds less valuable. For example, let's assume an investor purchases a bond that pays a fixed rate of 5%, but interest rates in the economy increase to 7%.
Is it true that US treasury security is risk-free? ›
U.S. treasury security is not strictly risk free. Though U.S. treasury securities are regarded as free from default risks, they are subject to various other risks: inflation risk: that rise in inflation reduces the real return on these bonds.
