U.S. Treasury Bonds Offer Stable Returns in Difficult Markets
Treasury bonds (T-Bonds) are long-term, semiannual bonds issued by the U.S. Treasury. Because they are backed by the full faith and credit of the U.S. government, T-Bonds are generally considered "risk-free" investments (at least when it comes to ). Because of their low risk profile, investors typically flock to Treasury bonds during economic downturns. have historically delivered solid gains during recessions and markets.
A Regular Income Payment
When a coupon rate." For example, let's say you buy a 10-year Treasury worth $1,000 that carries a 4% coupon rate. If you hold it until it matures, you can expect to receive $40 a year in interest and get back your $1,000 in 2018.is issued, it pays a fixed rate of interest, called a "
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If you sell the bond before it matures, however, the value of the bond will reflect changing interest rates. If interest rates on 10-year Treasuries were to rise next year to 5%, the bond you bought for $1,000 might sell for just $800, since an investor can earn more interest by buying a new bond at a higher coupon rate. At $800, the $40 in annual interest gives the bond a yield of 5% ($40/$800=5%). But if 10-year Treasury yields fell to 3%, your bond could increase in value to $1,333 to give it a yield equivalent to new Treasuries ($40/$1333=3%).
How Interest Rates Can AffectPrices
Investors should note a bond's "." is a complex calculation expressed in years that measures how volatile a bond can be as interest rates rise and fall. Simply put, if interest rates rise 1%, the price of a bond with a of five years is expected to fall by around 5%, but a bond with a longer of 10 years could lose some 10% of its value.
As you can see, investors who hold bonds with a longer(typically more than five years) may suffer greater losses when interest rates rise. But if rates fall, they could enjoy stronger returns since longer-duration bonds should rise faster than comparable bonds with shorter durations.
Like any metric, factors such as , derivatives, or credit quality can make a fund more volatile than its would predict. As a rule of thumb though, a long-term with a of 10 years would be about twice as volatile to changes in interest rates as a with an average duration of five years. As such, shorter-duration funds are more appealing to long-term income investors since their returns tend to be more stable.isn't foolproof. For example, fears can hurt long-term bond prices even when interest rates are falling, but have less effect on shorter-term bonds. In addition,
Investing in Inflation-Resistant TIPS
To help minimize the threat of inflation, a goodTreasury Inflation-Protected Securities (TIPS). TIPS are linked to the Consumer Price , so their value increases as consumer prices, including food and energy, rise.might be to invest in
For instance, say you buy a 10-year, $1,000 TIPS bond in March. If by June inflation rises +1%, your bond principal or the original $1,000, whichever is higher (if there is , the principal won't fall below its $1,000 ). The bond's interest payments also rise with inflation, as they are calculated at a fixed rate on the inflation-adjusted principal.would now be $1,010 (1.01 * $1,000). If you hold the bond until it matures in 2018, you will receive either the inflation-adjusted
[Use our to measure your annual return if you plan to hold a particular bond until Calculatormaturity.]
Interest income on Treasury bonds, including TIPS, is taxable as ordinary income at the federal level, but is not taxed on the state and local levels. As such, bonds and bond funds are best held in a tax-deferred or 401(k) account.
The Investing Answer: Treasuries and TIPS can be shining stars against a backdrop of doom and gloom in the financial markets. But when stocks rally, Treasuries lose some of their luster as investors rotate out of safety in search of growth potential. Still, with their risk-free payouts, Treasuries and the funds that hold them should provide a solid addition to any income portfolio.
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