Are Long-Term U.S. Government Bonds Risk Free?

Risk Overview

No debt obligation, whether U.S. government or corporate, is free of all risk. However, U.S. Treasuries of all maturities have long been considered safe from the risk of payment default.

That’s because they are backed by the full faith and credit of the U.S. government. Thus, due to the stability of the U.S. government, investors believe that the principal and interest amounts owed on the money that they loan the government when they buy its bonds (and notes and bills) will always be paid.

In addition, Treasuries are extremely liquid, meaning they’re easy to buy and sell. The secondary market in Treasuries is the most liquid debt market in the world.

So, U.S. Treasury bonds, also known as T-bonds, are often touted as risk-free investments. The collapse of the government and society could change that, but not many consider it a real possibility.

Importantly, though, long-term government bonds have other risks, such as the risks posed by changing interest rates and inflation.

We’ll look at those after delving into the concept of long-term T-bonds’ credit risk as it relates to payment default.

Key Takeaways

• No bond, whether issued by the U.S. government or a corporation, is free of all risk.
• But U.S. government treasuries, including long-term bonds, are considered to be free of the risk of payment default.
• The U.S. government has an excellent credit rating and repayment history, and can take necessary steps to service existing debt obligations.
• There are, however, other risks for the long bond, such as interest rate risk, the effects of inflation, and opportunity cost.

Government Debt and Credit Ratings

A government’s ability to pay off a debt obligation is measured by a country’s credit rating. Much like an individual’s credit rating is determined by his or her borrowing and repayment history, so too is the U.S. government’s.

How It Works

From time to time, governments will borrow funds from other countries and individuals through loans and bonds.

The servicing and repayment of these bonds are carefully measured by financial institutions for creditworthiness.

Specifically, these entities look at a government’s lending and repayment history, the level of outstanding debt, and the strength of its economy.

In 2024, the highly respected credit rating company, Standard and Poor’s, affirmed its second highest possible rating, AA+, for the U.S. government.

Because U.S. government bonds are backed by the U.S. government and the U.S. has the most powerful economy in the world, these bonds are widely considered to be free from the risk of payment default.

When you purchase this type of bond, the U.S. government guarantees that the interest and principal will be paid according to the bond covenants. That is, payments will be made on time and in full.

Potential Pitfalls

Some economists point to the 25% rule which states that any long-term debt that exceeds 25% of the annual budget is excessive. Other economists do not share this view.

Only a monumental downturn in the economy or, possibly, a very rare circumstance during a time of war would prevent the U.S. government from repaying its short- or long-term debts.

However, even such events are unlikely to result in the U.S. government defaulting, since it has the ability to print additional money (monetary policy) or increase taxes (fiscal policy) if additional capital is needed.

Important

While the U.S. government has never defaulted on debt payments, and the S&P expressed confidence in its ongoing stability and economic resilience, it noted in its 2024 credit assessment that “A high debt burden, with net general government debt approaching 100% of GDP and interest to revenue over 10%, and difficulties garnering bipartisan cooperation to strengthen U.S. fiscal dynamics are credit weaknesses.”

Long-Term Bonds Have Other Risks

Interest Rate Risk

All bonds have interest rate risk, which is the risk of a loss of value if interest rates increase.

When interest rates change, the prices of bonds also change, but they move in the opposite direction. And the magnitude of these moves correlates to maturity.

That is, the longer the maturity of a bond, the greater the price volatility due to changing interest rates.

Conversely, the price change for very short Treasuries, such as Treasury bills which have maturities of under a year, is relatively minor. In fact, that’s why T-bills are called cash equivalents.

So the risk of a substantial change in value for long-term bonds is real. A general estimate is that a rise in yield of 100 basis points, or, say from 4% to 5%, causes an approximate 10% loss of principal for a 30-year bond.

Inflation Risk

With regard to long-term bonds that investors hold on to, persistent inflation erodes the value of the interest and principal payments over extended periods of time.

That, in turn, reduces your investment return.

Rising inflation also affects the value of bonds. When inflation rises, interest rates rise. And, as explained above, as interest rates rise, prices for outstanding bonds fall.

The Opportunity Cost

Normally, long-term bonds offer higher returns than those with shorter maturities.

However, due to the perceived risk-free appeal of ongoing interest and principal payments no matter what, long-term bonds offer lower rates of return compared to certain other investments, such as the stock market.

That means that by investing in long-term bonds, you can lose out on more attractive returns offered by higher yielding securities. This doesn’t mean that you should avoid Treasuries. But it suggests that diversification is called for based on financial needs, investment goals, and your risk-return profile.

To illustrate, consider some historical returns. If you’d invested $100 in 1928 in the S&P 500, in 2024 your investment would have been valued at $982,817.

If you’d invested $100 in 1928 in Treasury bonds, in 2024 your investment would have been worth $7,159.45.

Advisor Insight

Peter J. Creedon, CFP®, ChFC®, CLU®
Crystal Brook Advisors, New York, NY

Many people consider U.S. government bonds as “risk-free” because there is a very slim perceived chance that the country will default.

In my opinion, interest rate risk is currently the greater concern. The coupon payments the U.S. government will pay you are fixed at issuance, but the markets may create volatility for the issue that will cause the bond price (principal) to rise and fall during the life (term) of the bond. If the market interest rate fluctuates while your coupon is fixed, this may cause your investment to change in value. Also, if you choose to sell your bond before maturity you may experience a decline of principal.

Like all investments, risk is an integral part of the process. Invest with knowledge, so you know what your risks are and their effects on your capital.

What Is Default Risk?

It’s the risk that an issuer of a bond will fail to make the agreed-upon payments of interest and principal to the buyer of the bond. They will default on their obligation.

Are Long-Term Treasuries a Good Investment?

Depending on your purpose for investing, they could be. If you prefer low risk investments that guarantee income payments of interest and principal over a long time period, they could be a good investment (as long as you also invest in other, higher yielding securities). Many individuals, organizations, and foreign governments purchase Treasury bonds for their portfolios.

Can I Sell a U.S. Treasury Bond Before It Matures?

Yes, you can sell it at any time or hold on to it until maturity. Bear in mind that its value can change over time due to changing interest rates and demand. So, while you lose nothing if you hold a bond to maturity, if you have to sell before then, you may get less than what you paid for it.

The Bottom Line

Long-term U.S. government bonds are considered to be risk free as far as payments of interest and principal are concerned. That’s due to the ongoing stability of the U.S. government and its long history of always paying its debt obligations.

However, long-term Treasuries have other risks, including interest rate risk, the risk that inflation will erode the value of income received over time, and the risk that you’ll miss out on more attractive yield opportunities.