It’s easy to dismiss owning U.S. Treasury bonds as a waste of time, but they play an important role in a portfolio.
Yields on 10-year Treasury bonds have been falling for decades. In July 1981, Treasury yields were more than 15 percent but have since dropped, paying just 2.3 percent recently. The falling yields led many to falsely predict the end of the bond market rally. Bond prices and yields move in opposite directions, so falling yields mean higher bond prices.
The problem with such low yields is they can’t keep up with inflation. The consumer price index for all urban consumers, one measure of inflation, increased 2.4 percent in the 12 months through March, according to the Bureau of Labor Statistics. Even without volatile food and energy costs, prices still rose 2 percent.
[See: 7 ETFs for a Solid Portfolio Defense.]
That low return after inflation is usually why some investors believe Treasurys aren’t worth owning. If these bonds were your portfolio’s only investments, it would be hard to disagree with that assessment.
Treasurys, though, become useful when they’re added to a balanced portfolio of stocks and other assets.
“They are the Armageddon security,” says David Nelson, chief strategist at Belpointe Asset Management in Greenwich, Connecticut. “If the economy rolls over, they will go up, even more so than gold.”
Smoother ride. That’s because when markets falter and the economy seems on the verge of recession, investors often dump stocks and buy Treasurys, sending their prices higher. The inverse relationship that Treasurys have to the prices of stocks and other risky assets help smooth a portfolio’s overall returns. Or to put it another way, holding some of these bonds reduces your portfolio’s total volatility, which most professional money managers equate with risk.
“Diversifying away some risk can provide a less volatile return, hence investors are more likely to stay fully invested,” says Stephen Wood, chief market strategist at Russell Investments in New York.
[See: 13 Ways to Take the Emotions Out of Investing.]
Big losses, often from stocks, make investors less willing to ride out the market’s ups and downs, but lower volatility isn’t the only reason to love U.S. government securities.
Good comparisons. Compared to the government bonds of other countries, U.S. Treasurys “have some of the highest yields in the world,” says Steven Wieting, chief investment strategist at Citi Private Bank in New York. “Italian government bonds have the same yield as U.S. bonds, but think about the credit risk.”
Italian bonds rate a BBB, the lowest bracket for investment grade, from various rating agencies, according to Trading Economics. If the rating drops, the bonds would move into a category considered speculative, or so-called junk debt. By contrast, U.S. Treasury bonds are mostly rated AAA, the highest category.
What to buy and how much. You can buy the bonds online from Treasury Direct, but mutual funds are another avenue for investing in them.
The Vanguard Long-Term Government Bond Index (ticker: VLGIX) has annual expenses of 0.05 percent, or $5 per $10,000 invested. Another alternative, the Fidelity Long-Term Treasury Bond Index ( FLBAX), has slightly higher annual expenses of 0.09 percent, or $9 per $10,000 invested, and is currently ranked No. 2 by U.S. News & World Report in the Best Long Government Bonds category.
You could also buy exchange-traded funds, such as the iShares Core U.S. Treasury Bond ( GOVT), which has annual expenses of 0.15 percent, or $15 per $10,000 invested.
[See: The 9 Best Municipal Bond Funds for Tax-Free Income.]
What percentage of a portfolio should be in U.S. government bonds? That depends on how risk-averse you are. For a reasonably stable portfolio, owning more Treasurys makes sense, but if wild swings in value don’t bother you, go with fewer bonds or even none.
A good starting point is to decide how much you want to allocate to all types of fixed-income securities — corporate bonds, junk debt and government bonds. Then make Treasurys one-third of that total fixed-income percentage.
More from U.S. News
9 Investing Myths That People Still Believe
10 ETFs That Pay Sky-High Dividends
10 Skills the Best Investors Have
The Case for Treasury Bonds originally appeared on usnews.com
