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Government Bonds and Our Economy

3985839229_dcc466eef9The government finances debt by selling U.S. debt obligations – Treasury securities or Treasuries.  The issuance of federal debt securities brings in money that’s used to pay for regular government spending.  In 2013, for example, the federal government ran a $680 billion budget deficit – financed by Treasury securities.  The issuance of new Treasuries is also used to pay off maturing debt securities.  And securities continue to be issued to fund war efforts.  All told, in 2013, the U.S. issued approximately $7.9 trillion in securities.

Who owns that debt?  Social Security funds hold 16% of the debt, other federal government funds hold 13%, the Federal reserve holds 12%, China holds 8%, Japan holds 7%, other foreign nations hold 19%, state and local governments hold 3%, mutual funds hold 6%, and all other holders account 17%.

The federal government issues three types of debt instruments:

  • Treasury bills are short-term obligations issued with a term of one year or less.  They do not pay interest before maturity.
  • Treasury notes mature in 2-, 3-, 5-, and 10-year terms.  They pay interest twice a year.
  • Treasury bonds are long-term investments that mature in more than 10 years.  They also pay interest twice a year.

Generally, shorter-term Treasuries pay lower interest rates because they’re less risky.  Because Treasuries are fixed-income securities, there is risk inherent in longer-term investment.  A 5% return might beat the market today, but will it still look good in two years – or five – or 20?  It’s easier to foresee how the market might change in three months than in 10 years: hence, the yields that longer term securities pay are typically higher.

Whether you should invest in government bonds depends on your risk appetite, your investment horizon, and your goals.  For example, if you are uncomfortable with relatively high levels of risk, Treasuries might match your risk appetite well.  If you’re investing for the relative short term – say, for retirement in five years – Treasuries of the same term might provide you the stability you need and the peace of mind that at least your principal is safe.  If your goal is to preserve capital, certain Treasuries can accommodate that goal, essentially earning just enough to protect against inflation.

If, however, you’re investing for retirement in 30 years, your portfolio likely needs to include higher risk, higher return investments like stocks.  Bonds still have their place, but they should make up a relatively smaller percentage of your total portfolio the further away you are from your investment goal and the more aggressive that goal is.

Is investment in government securities right for you?  What’s the appropriate allocation of bonds in your investment portfolio?  What type of bonds?  These are all important questions, so please call to discuss them in more detail.

Photo Credit: BLW Photography via Compfight cc

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