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Narrator: Government bonds are popular investments because of their perceived safety . However, not all government bonds are the same. In this video, we'll talk about two types: treasury and agency bonds. You'll learn how they're similar and how they're different. We'll also discuss some potential benefits and risks that come with bonds. Let's start with treasuries.
The U.S. Treasury was first established by Congress in 1789. The Treasury performs a number of duties, but in a nutshell the Treasury's job is to raise money for government expenses and pay the nation's bills. The Treasury typically raises money in one of two ways: through taxes and by issuing bonds to investors.
In the investing world, bonds issued by the U.S. Treasury are typically referred to as "treasuries." Treasuries are one of the most common fixed-income investments and might play an important role in your own portfolio.
Let's start with the basics. Treasuries are a loan investment, which means investors loan money to the U.S. government for a set period of time in exchange for a defined rate of return, known as a yield.
The length of time of the loan investment is known as the maturity.
Once an investor purchases a treasury bond, the investor receives regularly scheduled interest payments until the bond matures. At maturity, the federal government pays back the principal, or face value, amount.
Treasuries are classified into three types based on their length of maturity. Bills have a maturity of less than a year. Notes have a maturity of one to 10 years. And bonds have a maturity greater than 10 years. Typically, the longer the maturity date, the higher the yield.
Investors normally purchase Treasuries because they're considered to be generally safe investments.
They have this reputation because a Treasury's interest payments and return of investment principal is guaranteed by the full faith and credit of the U.S. government.
In fact, treasuries are considered to be so safe that they're commonly referred to as the "risk-free" investment.
But this isn't quite true; no investment is without risk. There's default risk, which is the possibility that the federal government won't pay what it owes. This has never happened in the U.S. but has happened in other countries.
There's also interest rate risk, or the possibility that an investment's value will fluctuate due to changes in interest rates. If you buy a treasury security and want your money back before maturity, you have to sell the treasury at its current market price. If interest rates have gone up since your purchase you may get less than what you invested. On the other hand, if interest rates have decreased, there's also a chance that you could get more than you invested.
As we said before, there are some key differences between treasury bonds and agency bonds. Agency bonds are similar to treasuries but instead of being issued by the government directly, they're issued by government agencies like the Federal Home Loan Bank, Fannie Mae, Freddie Mac, and Sallie Mae.
Despite being government-sponsored agencies, the assets they issue aren't backed by the full faith and credit of the federal government. Therefore, they aren't considered as safe as treasuries.
For example, during the 2008 mortgage crisis, Fannie Mae and Freddie Mac fell into distress and were expected to default. However, the federal government stepped in and guaranteed the principal and interest for the bonds.
Despite this bailout, agency bonds still have a higher default risk than treasuries.
Agency bonds are also subject to interest-rate risks and the amount can be higher than treasuries.
Now that you know how treasury and agency investments work and some of their risks, let's discuss how they can fit into your portfolio. Bonds are considered a fixed-income investment. Whether you're in the early stages of investing or in retirement, fixed-income investments are typically part of any well-balanced portfolio.
Treasuries and agencies can help you fill in this portion of your portfolio.
Treasuries can be purchased either directly from the Treasury or through a brokerage account. You could also invest in treasuries by buying shares of a mutual fund or ETF that invests in a more diversified group of treasuries. Agency bonds are more commonly purchased through your broker and can also be found in mutual funds and ETFs.
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