For those in the market to purchase U.S. Treasurys, it’s a little like hitting the local coffee shop for a small mocha. Or a medium one. Or a large. Or an extra large, an extra-extra large — and the jumbo of all jumbos, the 30-year.
Indeed, it might take a super-duper java to wrap your head around it all. Treasurys come in denominations based on the length of the bond, such as two-year, five-year and 10-year increments: 11 in all as offered by the Department of Treasury. Simply put, the longer the bond length, the higher its yield.
“Selecting the best maturities for Treasury bonds depends in part on the slope of the yield curve,” says Roger C. Tutterow, an economics professor at Kennesaw State University’s Michael J. Coles College of Business in Georgia. “Unless investors are confident they will hold the bond to maturity, they’re accepting interest rate risk — so the need to get paid for that — with higher yield on long-dated bonds.”
[See: 9 Financial ETFs Rising with Interest Rates.]
And therein lies the challenge. If a one-month Treasury has 1.95 percent return and a 30-year offers 3 percent, then where in between should investors fall?
First, it helps to know how exactly these investment vehicles work. Treasurys are bonds — money that you in essence loan to the U.S. government and that collects interest. These securities are also viewed as one of the safest investment options around. Unless the federal government itself defaults — and that would mean much bigger problems for all of us than bond prices — Treasurys are removed from the same financial forces that put stocks at peril.
Risk-free doesn’t mean Treasurys are bulletproof, though. Interest rate risk, for example, can knock Treasurys off balance. Rising market interest rates equal lower fixed-rate bond prices; falling rates equal higher prices. Think of a seesaw: the exact image the Securities and Exchange Commission uses in an investor education document that explains the phenomenon.
As for where the investor gets on and off that ride, so much depends on knowing ahead of time when you’ll need to tap the money you invest and the returns that accompany.
“It’s driven largely by one’s time horizon,” says Robert Johnson, professor of finance at Creighton University’s Heider College of Business. “For example, if one is accumulating a down payment for a home and plans on accessing the funds in say, two years, one should not invest in a 10-year bond. If you mismatch the maturity and the time horizon, you run the risk of losing money even though Treasury securities are risk free.”
In general, there’s no bad time to plunk down money in Treasurys — though some junctures are clearly more advantageous than others.
[See: 7 Things That Could Trigger a Stock Market Crash.]
“The current environment is particularly challenging for investors because the yield curve has been flattening over the past year, essentially bringing two-year bond yields close to 10-year bond yields,” says Angelo DeCandia, professor of business and accounting at Touro College in New York.
As of the start of the month, two-year Treasurys pay out 2.62 percent, while the 10-year stands just a touch above, at 2.86 percent. “Bond traders think of this as ‘the two-tenths spread’ and when it’s narrow, you have to question the wisdom of buying longer term bonds,” DeCandia says.
“If you know you’ll need the money, then don’t wait,” says David Ader, chief macro strategist at Informa Financial Intelligence and based in Stamford, Connecticut. “Don’t play the market. I don’t see rates beyond five to seven years going up much, but perhaps a bit — which again argues for buying bills and rethinking things when they mature in three or six months.”
Still, a sudden turn in the record bull market for stocks could change the equation entirely.
“This has been a very long cycle; stocks are very high — perhaps too rich — and if they get hit bonds will do well,” Ader says. “I’d start, soon, incrementally buying further out the curve if and when rates go up. I don’t see the 10-year going above 3.5 to 3.75 percent at most before the next recession takes yields lower.”
And so the risk behind this risk-free investment comes down to this: One bond does not fit all, any more than a short mocha consumed in one gulp will satisfy a jumbo drinker content to nurse their purchase for a long, long time.
[See: 8 Bond ETFs to Cope With Rising Interest Rates.]
“It will depend on many factors,” says London-based Peter Wilson, global fixed income strategist at Wells Fargo Investment Institute. Those include “the type of investor and the purpose of the investment, the point we’re at in the monetary policy cycle — that is, the investor’s view of interest rates in coming years — and the investor’s tolerance of risk and ability to maintain a position through short-term price swings. It’s all these and likely more.”
In other words, Wilson concludes: “There’s no single good answer.”
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Which Treasury Bonds Are the Best? originally appeared on usnews.com
