Asset Class Description: US Treasury Bonds

Posted on December 10, 2009 at 5:20 PM PDT by

Perhaps the most core asset class any investor needs for diversification in an ETF portfolio are US Treasury Bonds. Owners of treasuries have an investment in a portion of the public debt of the United States of America — backed by its full faith and credit. There is no risk of not getting repaid your principal at the expiration of the bond. Financial market crises often lead investors to flock to “safe” investments and US Treasuries. In October 1987 when the US stock market lost more than 20% in a single day, and 1998 when Asian, Russian, and US capital markets had a crisis — investors starting buying up bonds and driving the prices up.

But bond investors shouldn’t sleep as well as they think — the protection comes at a very high price. Bonds provide the lowest rate of return and over the years, inflation eats away a lot of the value of the monthly income. From 1925 – 2003, US Bonds only appreciated 5.4% per year or 61 times while stocks appreciated nearly 10.4% per year, or 8,000 times. The other price you pay for holding bonds is inflation – its bad for long term bonds. If you lend the government $100,000 in 2000 for 5% interest for 20 years and inflation runs rampant at 8% for most of the 20 year period, the government pays you back your $100,000 which might be worth a lot less by the time it is repaid to you. And all you got was your 5% per year. While bonds increase in value in a deflationary environment where prices are dropping, this is a rare economic circumstance.