United States Treasury Bonds, Bills, Notes are viewed as among the most secure investments because they are backed by the full faith and credit of the US government. That sounds good, right? Many of us look to treasuries as a safe way to provide income in retirement while preserving our principal.
Let’s take a quick look at what it means to buy a treasury.
Loaning Money to The US Government
By buying a treasury security, we are essentially loaning money to the US government. The treasury security has:
- a face or par value – this is how much the bond is worth at maturity. Typically par value is $100 or $1,000.
- a coupon – this is the interest rate that the security will pay. A 5% coupon pays 5% of face value per year.
- a maturity date. On the maturity date, interest payments cease and the par value is returned to the security holder.
Let’s look at a quick example. Today is Jan 14, 2025. I buy a $100 treasury note with a coupon of 4% and a maturity date of Jan 14, 2026.
I pay $100 today to buy a $100 face value (par value) note. Over the life of the note, I will receive interest payments semi-annually. Interest payments will be 4% annually or $4. I’ll receive 2 payments of $2 each. On Jan 14, 2026, the note matures and I receive my $100 back.
Pretty nice deal. I put up $100, get $4 in interest payments and get my full $100 back in a year. The government guarantees this loan so it is pretty reasonable to assume that I will get my interest payments and full return of principal.
How Can I Lose?
Sounds like the perfect investment. I’d prefer a higher interest rate, but you can’t beat the safety of loaning money to the US government. Despite the debt level and the overall political craziness going on, the US government has always met its debt obligations.
Time
Time is a factor. Bonds, notes and bills come in durations of under 1 year all the way up to 30+ years.
Tying my money up for 3 months or a year is fairly low risk. I buy my treasury security, get my semi-annual payments and wait 3-12 months to get my principal back. I can handle that.
But what about a longer bond – maybe 10, or even 30 years. The interest rate will be higher, but I need to commit to a much longer period. And if I’m looking for a safe income paying investment for my retirement, I’m probably looking to invest a good chunk of change.
Example Please
Let’s say I’m looking for some guaranteed income in retirement. Rather than dealing with my 401k or IRA investments and thinking about asset allocation, Maybe I’d like to cash out my 401k and take my $500,000 and buy a treasury bond.
Today, I can get a 20 year treasury bond that pays 5.1% interest. That means that I can invest my full $500,000 and the US government will pay me $25,500 per year, every year until 2045, when they’ll return my full $500,000.
That sounds awesome. Way better than an annuity, which makes regular payments but returns nothing in the end.
And with social security, this may be enough to live on.
But Wait, What If I Need My Principal?
Here’s where bonds get tricky. If I hold to maturity, treasury bonds are quite predictable. Not so for junk bonds, but that’s a story for another day.
With a treasury, I’ll get dependable coupon payments, and I’ll get my principal back at maturity.
But, like any other stock or bond, a treasury is a security that I can sell if I decide I need the money. And, like any other security, we will sell at market price. So, if I need my money, I can sell it.
Market Price
The face, or par, value of my treasury never changes. If I bought 500 treasuries with a face value of $1,000 each, The face value of each bond is always $1,000.
Given that, you would think that the market value for each bond is $1,000, right? Whoever I sell it to is going to get $1,000 for each bond in 2045, so they should be willing to pay me $1,000.
Not so fast.
We buy treasuries for the guaranteed income they provide. We bought these bonds to get the 5.1% annual income for 20 years.
What happens if interest rates go up, and new 20 year treasuries are offering 6%? No one will want my bond that pays 5.1%. I’ll need to discount it to compensate the buyer for the reduced interest.
Discounting
Maybe if I take $5 off each bond that will work?
Nice try. But let’s look at how the discount is calculated.
My bonds pay 5.1% interest or $25,500 per year. The new bonds pay 6.1% interest or $30,000 per year. That’s a difference of $4,500 per year, which ain’t chicken feed.
But these are 20 year bonds, so a buyer who buys our 5.1% bond will get $4,500 less in interest every year for 20 years. That’s $90,000 less.
We’ll need to discount our price by $90,000. that means I bought the bonds for $500,000 and I’m selling them for $410,000. I’ve lost 18%!
Really?
Don’t believe me? Ask the folks at Silicon Valley Bank (SVB). While SVB had a number of risk-management issues, one of their problems was that they had quite a bit of depositor capital tied up in 20 year treasuries. Seems like a safe move for a bank.
But what they didn’t plan on was interest rates rising as much as they did over the past few years. When depositors asked for their money, the bank needed to sell their low-interest rate treasuries at steeply reduced prices, to meet withdrawals. This strategy didn’t play out well and the bank went under.
Wrap-Up
Treasury securities guarantee a fixed rate of interest for a specified period and will return our principal at maturity. That’s pretty cool. I like to have them in my portfolio.
But we need to be aware that selling treasuries on the open market carries risk. If interest rates go up, the value of our security goes down. Not an issue if we’re holding to maturity, but could be an issue if we need to sell.
Conversely, our treasury could increase in value if interest rates go down. Everyone will want my 5.1% yielding treasury when new treasuries yield 4%. I can sell for a premium and make some coin.
To insulate myself from this risk, I often buy 1 year treasuries, but there is risk here as well. If I’m looking for a retirement income stream, I want to maximize my interest payments.
What happens if I buy $500,000 worth of 1 year treasuries today at 5.1% to get the $25,500 income stream. Let’s say rates go down and next year a 1 year treasury pays only 3%. My income goes down to $15,000. That’s a $10,500 haircut. I’m not sure I can live off of that. Shoulda bought the 20 year treasury to guarantee the 5.1% for 20 years
Summary
That’s a little more than I usually put in a wrap-up, so let’s summarize.
Treasuries are an important part of an investment portfolio, especially for retirees. We benefit from a dependable income stream with a return of principal at maturity.
What’s not to like?
But, like anything, we can’t put all of our eggs in 1 basket. While it may be attractive to move all of our 401k into a long-term treasury to get a larger income stream, we need to assess all of our capital needs. We may need money for healthcare or a home purchase. Tying all of our wealth up in treasuries may make this risky.
I love the predictable income my treasuries provide, but I also have lots of cash, as well as stocks and other types of bonds to help meet all of my spending and saving needs.
Read more about treasuries here.