Bonds, Treasury Bonds

There are numerous types of investment vehicles, or assets, available to you. Assets are economic resources. Each asset class theoretically has the same overall goal—to make money over time—yet each serves a different function in terms of risk and reward. Let’s review the most popular ones starting with Treasury Bills and Bonds. (They asset class in this discussion and the next one are listed from the lowest- to the highest-risk investments.)

Treasury Bills: Treasury Bills, or “T-Bills,” are the instrument the U.S. government uses to borrow money for less than one year. Safety is the key function of T-Bills, because they have never gone down in value. These days, however, T-Bills don’t go up much in value, either. Since they mature in less than one year, the risk of interest rate changes is minimal. Depending on how you calculate it, the rate of return is typically around 0.9% above the rate of inflation. That’s not much of a return, but that’s not the purpose of T-Bills; the purpose is safety. If your risk tolerance is low (e.g., upon retirement), it is appropriate to move more of your money into this asset class.

Long-Term Treasury Bonds: “T-Bonds” provide a slight increase in return in exchange for a longer maturity period – typically ten–30 years. In December 2015, the T-Bond rate was 4.615%. In December 2001, the rate was 8.283%. Over the past 30 years, the interest rate for T-Bonds has remained roughly in the range of 3–9%.

Bonds are in your portfolio to provide safety. Long-term bonds tend to go up when the stock market goes down because of what is called a “flight to quality.” When people panic, they buy what they believe is stable, and safe: U.S. government bonds. Why? The government can tax and print money, and will not go bankrupt. Investors can feel comfortable that they will get their money back. As the demand for bonds goes up, so does their value. But they still carry some risk.

Between the 1920s and the 1980s, interest rates rose, but ever since then they have declined. In 2009, the trading value of T-Bonds dropped an average of 14.9%. Indeed, from 2010 through 2015, short-term interest rates were at the lowest possible rate – 0.25% – with two-year bonds also returning less than 1% during this period. Although T-Bonds recently received a nominal bump up to 0.5%, current interest rates remain essentially at 60-year lows.

In 2002, when the stock market went down 22%, intermediate-term bonds (those maturing in three–ten years) experienced a 16% return. That’s even better than it looks, because these intermediate-term bonds went up 16% up when Large U.S. Stocks went down 22%. In 2008, when Large U.S. Stocks went down around 40%, intermediate-term bonds rose 13%. That is the purpose of bonds in your portfolio: they provide safety just when you need it most.

Fixed Income: Fixed income investments are typically municipal bonds or treasuries that pay a predictable premium on a regular schedule.