A bond is a set amount, typically between $1,000 and $5,000 US Dollars, issued as a paper contract to a buyer. The buyer gives the government the amount of money stated on the Treasury Bond and in return the US Treasurer, in this case the bond issuer, agrees to pay back the face value amount of the bond.
In addition, and similar to any loan, US government bonds agree to pay annual interest payments on the amount borrowed to the purchaser. So when you buy a Treasury bond or the shorter term Treasury notes, you are essentially loaning the US Treasury money with the promise not only of interest payments but the return of the principal when the Treasury bonds mature. Purchasers of Treasury Notes and Treasury bonds can be ordinary investors, banks, and foreign governments.
Benefits Of Government Bonds
Government bonds are extremely beneficial to both the consumer purchasing them as well as the Federal Government. Since World War 1 the US Government has recognized a need to borrow money in order to maintain the economy.
The use of government bonds is an effective tool which does just this. While the government is able to keep the economy moving and pay its bills, government bonds are also good for the investors who purchase them.
A government bond is without comparison the most secure investment one can make. Any stock purchase or corporate comes with an inherent risk: the company may fail.
With government bonds that “company” is now the United States of America. Chances are, you will get your investment back.The Risks
Rising inflation is a major risk to bonds because it pushes up interest rates. And if interest rates go up, bond prices drop. If you buy a bond and then have to sell when interest rates have gone up, you will realize a lower overall return on your investment. If you hold the bond until it matures, you might not keep ahead of inflation.
Another risk is called re-investment risk. You might be satisfied with the interest income you're earning on a bond now, but when it matures in 10 years things might be different. You might find that the yields on bonds are too low to meet your income needs.
This is a concern for people in retirement. You can counteract some of these risks buy buying bonds of staggered maturities, say 5, 10 and 15 years. When each of the bonds matures you can reinvest the money at the prevailing long-term rates. A slight risk with bonds is that the government that issued it won't be able to pay interest or repay the face value. The risk is slight, but it should be taken into account, especially if you're buying a long- term bond of 20 or more years. One thing is now very clear: government bonds are no longer the risk-free assets they once were. This carries far reaching implications for policymakers, central bankers, debt managers, and how the demand and supply sides of government bond markets function.
If you are considering Retirement Planning, call for a free consultation today.
