Treasuries Are the Safest Investment

United States Savings Bond Background
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U.S. Treasuries are securities that are issued by the United States government that which allow it to raise money to help cover the costs of operations and fund programs. These Treasuries are sold to investors, who are generally looking for the safest, lowest-risk investment available.

Treasuries come in the form of Treasury bills (T-bills), notes (T-notes), and bonds (T-bonds). T-bills are securities that have a short maturity span of up to a year. The maturity rate of T-notes ranges from two to ten years, while T-bonds have a maturity rate of 30 years.

The options provided by these U.S. Treasuries, combined with Treasury Inflation-Protected Securities, Floating Rate Notes, Series I Savings Bonds, and Series EE Savings Bonds, provide investors with government-backed investment options that are guaranteed to pay their face value when held to maturity. However, there are some risks involved, such as inflation and interest rate risk, but the risk is much less than that of investing in stocks and bonds on the market.

Key Takeaways

  • If you keep a Treasury to maturity, you are guaranteed to get back at least the value of the original investment.
  • There is risk of Treasuries losing value due to inflation, or if they are sold before maturity when interest rates are high.
  • One downside to investing in Treasuries is the low yield, since your money could be earning more in higher-yield (though riskier) alternatives.

The Safest Investment

Treasuries are backed by “the full faith and credit” of the U.S. government, and as a result, the risk of default on these fixed-income securities is next to nothing. Since the initial formation of the government in 1776, the U.S. Treasury has never failed to pay its lenders back.

The number-one reason that U.S. Treasuries are considered to be safe investments is that when you buy a Treasury bill, bond, or note, you are guaranteed by the government to receive the face value of your investment, as long as you hold it to the maturity date.

Investors also tend to turn to T-bonds in times of economic recession. As prices fall during a recession, T-bond yields tend to increase. When the economy begins to recover, and market interest rates go up, investors tend to turn away from T-bonds as prices fall.

However, the fact that a principal investment is protected does not mean that Treasuries are completely risk-free. In fact, holding Treasuries poses some very specific risks like inflation risk, interest rate risk, and opportunity cost.

Inflation Risk

If the inflation rate rises, the value of Treasury investments may decline. That is called "inflation risk." Consider, for example, that you own a treasury bond that pays interest of 3.32%. If the rate of inflation rises to 4%, your investment's rate is not keeping up with the rate of inflation. To put it another way, the value of the money you invested in the bond is declining. You’ll get your principal back when the bond matures, but it will have less purchasing power than when you invested it.

One way of minimizing inflation risk is to invest in TIPS—Treasury Department investment vehicles called Treasury Inflation-Protected Securities. Alternatively, you could invest in mutual funds holding TIPS.

Interest Rate Risk

The second risk of holding Treasuries is interest rate risk. If you hold the security until maturity, interest rate risk is not a factor. You’ll get back the entire principal upon maturity. But if you sell your Treasury before it matures, you maight not get back the amount of money you invested.

Remember, bond prices have an inverse relationship to interest rates. When one rises, the other falls. For instance, if you purchased a 4% Treasury note two years ago, interest rates may have risen, with a similar Treasury note paying 5% interest. The 4% Treasury note will sell at a discount and likely won't return all of the principal originally paid.

The 4% note will be discounted until the current yield equals, or is very nearly equal to, the 5% interest paid on similar Treasuries being issued. Depending on the interest rate difference, that can result in a substantial loss of principal.

Opportunity Cost

Treasuries are so safe that they don’t have to pay much to attract investors. As a result, the yields on Treasuries often fall short of the yields on even very safe, AAA-rated corporate debt. (A Standard & Poor's credit rating—AAA is the highest.) That doesn’t cause a loss of capital, but it could cost you the opportunity for a higher return on another investment.

Opportunity cost is the difference between what you earn from an investment and what you could have earned if you had invested in something else.

Most investors consider the opportunity cost of keeping more than small amounts of cash in a savings account to be too high.

Treasuries have higher interest rates than savings accounts. Often, they don’t pay much more than a savings account rate. If you invest in Treasuries, more often than not you could have profited more with another safe bond investment. That is one of the biggest risks for Treasuries investors—that in being too risk-averse, they've invested too heavily in low interest-rate Treasuries.