Question
Treasury bonds, like all bonds, are subject to interest rate risk. This means that their value can fluctuate based on changes in the general level of interest rates.
When interest rates rise, the price of existing bonds fall. This is because new bonds are issued at the higher interest rate, making the lower-yielding existing bonds less attractive. Conversely, when interest rates fall, the price of existing bonds rise, as they yield more than new bonds issued at the lower interest rate.
However, the impact of interest rate changes on a bond's price can be mitigated by holding the bond until maturity. At maturity, the bondholder receives the bond's face value regardless of current interest rates.
Therefore, while interest rate risk can affect the market value of Treasury bonds in the short term, it does not affect the bond's value at maturity.
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Unless investors are in the lowest tax bracket, they should purchase only tax-free municipal bonds. The only place to own taxable bonds is inside the 401(k) account. As interest rates rise, short-term bonds fall less than long-term bonds. But when interest rates fall, a long-term bond will outperform short-term ones. Therefore, to avoid guessing interest rates, it's best to buy bonds that mature in five to 10 years as they remain relatively stable. Bond funds are a better idea than individual bonds as they offer an easy way to diversify and reduce risk.
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