Pssst... Want to make 4.4%, guaranteed?
That sounds pretty good in this time of low interest rates. According to BankingMyWay.com surveys, money market accounts average just 0.44%, savings accounts 0.232% and one-year certificates of deposit only 1.141%.
Getting 4.4% on a 30-year U.S. Treasury bond sounds pretty good. Until you take a closer look. These days, it probably makes sense to stay away from fixed-income investments with so many years to maturity.
Even though Treasuries are guaranteed by the government, which has never defaulted on this kind of debt, there are big risks, depending on which of two investment approaches you choose.
Approach #1: Buy and Hold
The first is to buy with the intention of holding the bond until it matures. All bonds are loans from the bond buyer to the bond issuer. You pay, say, $1,000 for a bond yielding 4.4% and you’ll get $44 a year for 30 years, and then the government will return your $1,000 principal.
Many corporate and municipal bonds carry a risk of default, when the issuer fails to make the promised interest payments or fails to return the investor’s principal. With Treasuries, the default risk is all but non-existent.
The chief risk for the buy-and-hold investor is in having money tied up in the bond while other investments are more generous. If interest rates shoot up to 7% or 8%, you’d probably kick yourself for being locked in to 4.4% for three decades. Inflation is a factor, too. If it picked up to, say, 4%, your bond’s purchasing power would really be growing at just 0.4%.
Approach #2: Buy and Sell
Although bond yields are expressed as a percentage, the annual coupon payments are fixed dollar amounts. The $1,000 bond yielding 4.4% will pay $44 a year for 30 years, but the bond itself might not always be worth $1,000.