The Risk of Long-Term Government Bonds
Long-term government bonds have maturities of 10 years or more. U.S. Government bonds are considered the safest investments because they are backed by the full faith and credit of the U.S. Government, which guarantees the timely payment of interest and principal at maturity. But the government does not guarantee against market losses, which in long-term bonds can be substantial.
Other People Are Reading
-
Face Value, Discounts and Premiums
-
Once issued, bonds trade in the secondary market at par, or face value (the official contract amount to be repaid at maturity), at a discount (below par) or at a premium (above par). If an investor buys a bond at face value and it trades at a discount, he will have a paper loss, but if he holds the bond to maturity, he will get back the full face value. He will only realize the loss if he sells the bond in the secondary market at a discount.
Maturity
-
The longer the maturity, the more the bond fluctuates in the secondary market and the greater its discount can be. Longer-term bonds carry more uncertainty. An investor can usually get his money back if he only has to wait a year or two until the bond matures, but if a bond has 10 or 20 years until maturity, a lot can happen to the investor and the bond, so the risks are greater.
-
Personal Risks
-
An investor holding a 20-year bond does not know whether he will need the money in the future. He may need to raise capital to start a business, send his kids to college or pay for unexpected expenses, or he may find a more compelling investment opportunity. U.S. Government bonds are very liquid -- he can always sell them in the secondary market -- but the unknown is how much he will be able to get for the bond.
Bond Risks
-
Bond prices fall when interest rates rise. In a rising interest rate environment principal losses can easily exceed interest income, producing negative total returns for investors for years. If an investor has a paper loss in a 20-year bond, he has some tough choices to make: Sell to cut his loss; hold, risking an even bigger loss if interest rates continue to rise; or wait 20 years to get his money back.
Inflation
-
Inflation erodes the purchasing power of fixed income assets: When prices rise, the fixed interest income payments you receive will buy less and less. You never know what inflation will be a couple of years from now, much less in 10 or 20 years, so by holding a long-term bond you risk losing a lot of purchasing power if we go through a period of high inflation.
-
