Advantages and Disadvantages of U.S. Treasury Bonds and Notes

By Markets Fool.com

Every balanced portfolio has at least some allocation to fixed-income securities, and U.S. Treasury bonds and notes are among the most popular debt instruments in the world. Investing in U.S. government securities has its pros and cons, and fixed-income investors need to understand them in order to make a smart decision about whether to include them in their portfolios.

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The advantages of Treasury securities
Treasury bonds, notes, and bills are all types of U.S. government debt. Bonds refer to debt with a maturity of 10 years or more, while notes are issued for terms of two to seven years and bills cover obligations that are payable in a year or less.

Regardless of the name, all Treasury securities are backed by the full faith and credit of the U.S. government. That effectively eliminates default risk, because the government can always mint new money that it can use to repay Treasury debt.

Another key advantage of Treasury securities is their liquidity. The market for Treasuries is large and extremely active, making it easy to buy or sell Treasury bonds, notes, or bills in whatever quantities and maturities you want. Moreover, the Treasury consistently sells new Treasury securities at auction, and the public can participate to buy Treasuries directly from the government without going through a bond broker.

Disadvantages of Treasury securities
Despite their advantages, Treasuries aren't the perfect bond investment for every investor. One problem is that because they are seen as the lowest-risk bonds in the market, their yields tend to be relatively low. By contrast, corporate bonds typically carry higher interest rates, offering the potential for investors to get more income from the same principal investment. The higher yield compensates investors for taking on the risk that a corporate issuer will default on its debt obligations.

Treasury securities are also subject to many of the same risks as other fixed-income instruments. If interest rates go up, then Treasury prices will go down, and in general, the longer the maturity of the Treasury security, the greater the drop will be. That means that Treasury bonds have the greatest interest rate risk, with notes having somewhat less and bills have little or no exposure. Similarly, for foreign investors, currency risk is involved because Treasuries are all denominated in U.S. dollars.

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For bond investors, Treasury securities carry a reputation for being the safest way to invest in fixed income. Even though they have their trade-offs, Treasuries can make a good addition to most balanced investment portfolios.

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