By Barden Winstead
Telegram Columnist
Monday, June 18, 2007
In order to create a diversified portfolio of equities and fixed income securities, it is important to consider various types of investments that may offer different levels of return and risk.
You may want to invest in the stock and futures markets for potentially high returns, but you should balance out your need for high risk/return with lower risk, or less volatile investments. Some of the highest quality investments to consider come in the form of U.S. Treasury securities.
Treasury securities are backed by the full faith and credit of the U.S federal government for the timely payment of interest and principal, which gives them the highest credit quality available in the fixed-income markets. These securities also typically offer a high degree of liquidity, a state tax exemption, as well as a wide selection of yields and maturities.
Liquidity: The secondary market for U.S. government securities is active, giving you the ability to buy or sell them at any time. It is important to remember that, as with any investment, the price of government bonds will fluctuate depending on current interest rates and market conditions. Should an investor sell a treasury security before it matures, they could lose part of the principal invested.
State Tax Exemption: Interest income from Treasury securities is free from state and local taxes, but subject to federal income tax.
Wide Selection of Yields and Maturities Plus Predictable Income: Government securities are available in maturities ranging from four weeks to 30 years, making them attractive whether you are investing short or long term. In addition, government securities provide you with predictable interest income.
When considering treasury securities, you will have three forms to choose from, either bills, notes or bonds. Although all three types of Treasury securities trade actively on the over-the-counter market in large volumes, each of these investments differs with regard to yield, maturity and the way they pay interest.
Treasury Bills (T-Bills): These are short-term government securities issued with maturities of four weeks to six months. With T-bills, you do not receive any interest payments. However, they are usually purchased at a discount and at maturity you receive the face value of the bill. The difference between your purchase price and the face value represents how much interest you've earned on your investment. Because T-bills offer the shortest maturity available on a government security, there is less risk your money will be locked into a lower, less desirable yield should interest rates rise. However, if interest rates fall, investors would be subject to reinvestment risk.
Treasury Notes: These are issued with maturities of two to 10 years. They pay a fixed rate of semiannual interest and at maturity you receive the face value of the note. Bills are noncallable, which means the issuer cannot redeem the securities before their stated maturities. Yields on treasury notes are generally higher than Treasury bills but lower than Treasury bonds. However, at times, yields on bills can be lower than bills due to changes in the economy and interest rates. This condition is known as an inverted yield curve. They may be suitable for an intermediate- to long-term investment time horizon.
Treasury Bonds: These are long-term government securities with maturities extending beyond 10 years. Like treasury notes, these securities generally pay a fixed rate of semiannual interest, and you receive the face value of the bond at maturity. Because Treasury bonds are long-term investments, their yields are generally higher than the yields of Treasury bills or notes. Again, should the yield curve invert (short-term yields higher than longer-term yields) this may not be the case. Treasury bonds may be appropriate if you have a long-term investment time horizon.
It is important to keep Treasury securities in mind as you seek to diversify your more aggressive holdings. Historically, they have helped to reduce volatility in portfolios composed primarily of stocks. Proper diversification between asset classes is the key to any portfolio. Talk to your financial consultant today for more information.
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