Treasuries are widely considered the safest investments in the world. And there’s no doubt that they have earned that reputation.
Treasuries are backed by “the full faith and credit” of the U.S. government. The risk of default on these fixed-income securities is nil. Not even the safest corporate bond in the world can make that claim. if you're primary goal is to not lose money, treasuries are for you. When you buy a Treasury Bill, Bond or Note you’ll get your interest payments and you’ll get your principal back.
No problem.
That’s not to say that Treasuries are risk-free. There are, in fact, two very clear risks to holding Treasuries.
First, there is inflation risk.
If inflation rises, the value of your investment may decline. Consider, for example, that you own a Treasury bond that pays interest of 3.32 percent. If the rate of inflation rises to, say, 4 percent, your investment is not “keeping up with inflation.” Or to put it another way, the value of the money you invested in the bond is declining. You’ll get your principal back when the bond matures, but it will be worth less.
Note: there are exceptions to this rule. For example, the Treasury Department also sells an investment vehicle called Treasury Inflation-Protected Securities.
Second, there is interest rate risk.
Remember, bond prices have an inverse relationship to interest rates. When one rises, the other falls.
If you have to sell a Treasury before it matures, the price you can fetch will be based on the interest rate environment at the time of the sale. In other words, if rates have risen since you “locked in” your return, the price of the security will fall.
Note: If you hold the security until maturity, interest rate risk is not a factor. You’ll get back the entire principal upon maturity.
There’s a third factor that can be considered a risk, but it’s a bit of a stretch. Nonetheless, it’s worth discussing.
Treasuries are so safe that they don’t have to pay much to attract investors. As a result, the yields on treasuries often fall far short of the yields on even very safe, Aaa-rated corporate debt. That doesn’t cost you money, but it could cost you the opportunity for money.
In finance, opportunity cost refers to the difference between what you earn on an investment and what you could have earned if you had invested in something else. The opportunity cost of keeping more than small amounts of cash in a savings account, for example, is generally considered too high for nearly all investors.
Treasuries aren’t quite a savings account. But they don’t pay much interest. And if you invest in treasuries, you almost always could have made more money someplace else. Thus the biggest risk for treasuries investors may be that in being too afraid of risk, they invested too heavily in treasuries.