Lowest-Risk Bonds: What Types of Bonds Are the Safest?

If preserving your principal is important to you, you have an abundance of options to consider from bonds and bond mutual funds. While low risk also equates to low return, many people—such as retirees and those who need to access their savings for a specific short-term need—are more than willing to give up some yield to be able to sleep at night.

With that in mind, here are eight of the leading options in the low-risk segment of the ​​fixed income market.​​

1. Savings Bonds

These are the safest investment since they’re backed by the government and guaranteed not to lose principal. They don’t offer exceptional yields, but that isn’t the point. If you want to keep your money safe, savings bonds are the best option. They’re easy to buy through ​TreasuryDirect, and they're tax-free on both the state and local levels. They may also be tax-free on the federal level if used to pay for education. The one drawback is that they aren’t as liquid as some other types of investments. You can’t cash them in within the first year of their life; if you have to cash them in within the first five years, you will pay a three-month interest penalty.​

2. Treasury Bills 

Treasury bills (T-bills) are short-term bonds that mature within one year or less from their time of issuance. T-bills are sold with maturities of four, eight, 13, 26, or 52 weeks. Because the maturities are so short, they often offer lower yields than those available on Treasury notes or bonds. Their short maturities also mean that they have no risk. Investors don’t have to worry about the U.S. government defaulting in the next year, and the interval is so short that changes in prevailing interest rates don’t come into play. T-bills are also easily bought and sold via TreasuryDirect.

3. Banking Instruments

Banking instruments, like certificates of deposit and savings accounts, are among the safest options you will find in the fixed income market, but they come with two caveats. First, be sure the institution where you hold your money is FDIC-insured. Second, make sure your total account is below the FDIC insurance maximum of $250,000. Neither of these investments will make you rich, but they will give you the peace of mind that comes with knowing that your cash will be there when you need it.

4. U.S. Treasury Notes and Bonds 

Despite any fiscal problems of the U.S. government, longer-term Treasury securities are still entirely safe if they are held until maturity. Before maturity, their prices can fluctuate substantially. As a result, if you prioritize safety, be sure that you won’t need to cash in your holdings before their maturity dates. Also, keep in mind that a mutual fund or exchange-traded fund (ETF) that invests in Treasurys does not mature. That means there is the risk of principal loss.

5. Stable Value Funds 

Stable value funds are an investment option in retirement plan programs such as 401(k)s and certain other tax-deferred vehicles, They offer guaranteed return of principal with higher returns than typically available in money market funds. Stable value funds are insurance products; a bank or insurance company guarantees the return of principal and interest. The funds invest in high-quality fixed-income securities. Maturities average about three years, and this is how they can generate their higher yield.

The benefits of stable value funds are principal preservation, liquidity, stability, and steady growth in principal and returned interest. Returns are similar to intermediate-term bond funds but with the liquidity and certainty of money market funds. Keep in mind, though, that this option is limited to tax-deferred accounts.

6. Money Market Funds

While not government-insured, money market funds are regulated by the Securities and Exchange Commission (SEC). Money market funds invest in short-term securities, such as Treasury bills or short-term commercial paper. These are liquid enough that managers can meet the need for shareholder redemptions with little difficulty. Money market funds seek to maintain a $1 share price, but they could fail to meet this goal. This event is known as “breaking the buck.” This is very rare, so money market funds are seen as one of the safest investments. At the same time, they are often among the lowest-yielding options.

7. Short-Term Bond Funds 

Short-term bond funds most often invest in bonds that mature in one to three years. The limited amount of time until maturity means that interest rate risk is low compared to intermediate- and long-term bond funds. Still, even the most conservative short-term bonds funds will still have a small degree of share price fluctuation.

8. High-Rated Bonds 

Many debt securities carry credit ratings. These allow investors to figure out the strength of the issuer’s financial condition. Bonds with the highest credit ratings are very unlikely to default, so that is rarely an issue for them and the funds that invest in them, but as with Treasury notes, even high-rated bonds are at risk of short-term principal loss if interest rates rise. This isn’t an issue if you plan to hold an individual bond until maturity, but if you sell a bond before its maturity date—or if you own a mutual fund or ETF that focuses on higher-rated bonds—you are still taking on the risk of principal loss. It doesn't matter how highly rated the investments are.

The Bottom Line

Naturally, investors don’t need to choose just one of these categories. Diversifying among two or more market segments is preferred since you avoid putting all of your eggs in one basket. The most important thing to keep in mind is that under no circumstance should you try to earn extra yield by putting money into investments that have more risk than is appropriate for your objectives.

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