When stocks dropped following the announcement of new tariffs on imports to the US, many investors initially sought shelter in US Treasury bonds, which have long been viewed as safe places to put money when stocks turn volatile. This time, though, Treasury prices took a brief but unexpected dip alongside stocks before stabilizing.
While it remains unclear who was selling Treasurys and why, the brief sell-off shouldn’t obscure the fact that US government bonds remain among the most widely traded and least-risky assets that investors can buy to help diversify their portfolios. That matters because diversification remains one of the best ways for investors to manage risk in an uncertain market environment. And while diversification is always a good idea, investors should consider that Treasurys also currently offer attractive and reliable yield payments. However keep in mind, diversification does not ensure a profit or guarantee against loss.
What’s up—and down—with yields?
Since the 2008 financial crisis, Treasury yields have risen or fallen largely based on the monetary policy of the Federal Reserve. As the economy recovered following the financial crisis the Fed began raising rates in December 2015. But in 2019, it began to cut them as the economy struggled, ultimately slashing them to zero in the face of COVID-related shutdowns. Later, when inflation surged, the Fed pushed up interest rates to fight rising prices. Now, as the recent sell-off showed, market forces are also influencing yields and may move Treasury prices and yields in directions that differ from where the Fed and other policymakers might wish them to go. To some extent this is a good sign as it represents a return to historically typical and healthy market conditions where investors demand higher yields in exchange for locking up their money in longer-term bonds, a concept known as a term premium. It also may reflect heightened concern by investors about trade policy and the level of the federal government’s debt as a percentage of the US economy. That may make Treasury prices and yields more volatile than they had been in the past few years.
For now, though, Treasury yields remain above where they have been for most of the period since the 2008 financial crisis. These bonds offer investors who are willing to hold them to maturity an opportunity to earn attractive yields with very little risk of default. That may make this a good time for income-seeking investors to consider Treasurys and the role they could play in their investing plan.
Are Treasurys risky?
Treasurys have long been considered low-risk investments because they're backed by a promise from the US government to repay the bond's face value amount plus interest. That promise in turn is backed by the government's ability to raise the money necessary to make those payments through taxes, as well as by the relative strength of the US economy. While recent policy uncertainty is raising concern that US economic growth could slow, history shows that Treasurys have been among the least- volatile assets during past recessions. Longer-maturity Treasury bonds also may help you sleep at night by delivering reliable income and diversification when the economy eventually slows. Stocks, high-yield bonds, and other more volatile types of investments have historically struggled when economic conditions have worsened, while Treasurys and other high-quality bonds have performed better.
Treasurys are also some of the most widely traded of all securities. That makes it easy to buy and sell them at the price you expect to pay or receive, which is not the case for stocks and some other types of bonds. Bear in mind, though, that Treasury prices in the market are always changing and you could lose principal if you sell your Treasury bonds before they mature. If that is something you may want to do, choosing Treasury bonds with shorter maturities could help manage that risk.
Inflation is also a concern for those who look to Treasurys for income. Inflation reduces the buying power of interest payments from most Treasurys and other bonds, which do not rise with inflation. If you want the benefits of Treasurys but believe that inflation is likely to remain high, or even increase, you may want to consider Treasury Inflation-Protected Securities (TIPS), whose yields adjust based on changes to the consumer price index.
Treasurys and taxes
Another attractive feature of Treasurys is that the interest income they pay is exempt from state and local income taxes, though it is subject to federal income taxes. There may also be tax consequences when you sell Treasurys that you bought on the secondary market. If you buy a bond for less than face value on the secondary market and either hold it until maturity or sell it at a profit, the gain will be subject to federal and state taxes. This is different from buying a Treasury bill at original issue discount (OID). When a bond is sold or matures, gains resulting from purchasing a bond at a discount in the secondary market are treated as capital gains while OID gains are taxed as income.
How to add Treasurys to your portfolio
If you’ve decided that you want Treasurys, your next decision may be what kind of Treasurys. You can choose from 3 types: Notes, bonds, and bills. Notes and bonds differ only in name and in the length of time before you get your money back. Notes are available with maturities ranging from 1 to 10 years while bonds can have maturities of as long as 30 years. Both pay you interest every 6 months at a rate that is set at the time you buy the bond. Even if rates on newly issued notes or bonds rise or fall during the time you own your Treasury security, the rate you were promised when you bought it will remain unchanged.
The Treasury also sells securities called Treasury bills that do not pay interest on a regular basis. Instead, they are sold at prices below their face value (also referred to as "par value") and buyers receive the full face value when the bills mature in 4 to 12 months. Bills are also known as original issue discount (OID) bonds, since the difference between the price at issuance and the face value at maturity represents the total interest paid in one lump sum. Treasury bills may be attractive to some investors because the lump-sum payments eliminate the need to keep track of regular coupons.
As with other types of bonds, one of the most important differences among the various types of bonds is the length of time before they mature. Typically, bonds with longer maturities pay higher yields as compensation for the fact that they lock up your cash for a longer period of time. You may want to consider adding Treasury bonds with a variety of maturities in what is known as a bond ladder.
Besides the question of which maturities you may want, you'll also need to consider whether to buy newly issued individual bonds from the US Treasury, existing individual bonds in what is known as the secondary market, or shares of a mutual fund or ETF that holds Treasury bonds.
Newly issued bonds are offered at regularly scheduled auctions held by the Treasury. The price you pay—and the yield you receive—of a new issue Treasury bond reflects what others are paying at the auction and may differ slightly from what you may have expected to pay and receive.
If you don't want to wait for the next scheduled auction of new bonds, you can buy existing bonds. If you choose the secondary market, you'll receive a quote that tells you the price you will pay and the yield you will receive. Whether you choose new or used, Treasury securities are backed by the full faith and credit of the US government and both types of orders can be placed through Fidelity.
You can also get exposure to Treasury securities through mutual funds and ETFs whose managers buy and sell Treasurys in the course of managing these funds. Many funds use Treasurys to provide ballast for their overall portfolio and offset exposure to potentially higher-yielding but more volatile bonds and stocks.
You can research or buy Treasurys quickly and easily. Fidelity can also offer help if you want to add Treasurys to your portfolio. Our specialists in fixed income are available to answer questions and help you find bonds that may be a good fit for your investment strategy.