The Role of U.S. Treasury Securities in an Investment Portfolio
The primary advantage of U.S. Treasury securities is safety. No other investment carries as strong a guarantee that interest and principal will be paid on time. Because these payments are predictable, many people invest in them to preserve and increase their capital and to receive a dependable income stream.
The benefit of predictability is enhanced by the fact that Treasuries generally do not have “call” provisions. In fact, the U.S. Treasury has not issued “callable” securities since 1985. Call provisions, common in municipal and corporate bonds, permit the issuer to pay off the bond in full before its scheduled maturity. This is especially likely to happen when interest rates decline, as an issuer will refinance its debt to obtain the lower prevailing interest rate. When that happens, the investor would be forced to pay more to earn the same interest rate. If you own Treasuries that have no call provisions, you know exactly how long your income stream will last.
Another advantage of Treasuries is that they are available with a wide range of maturity dates. This allows an investor to structure a portfolio to specific time horizons.
Because many consider them the safest investments available, Treasury securities pay somewhat lower interest rates than other taxable fixed-income investments. Many investors accept this as a trade-off for security. In a diversified portfolio, U.S. Treasury securities usually represent money that investors want to keep safe from risk.
An added benefit of Treasuries is that their interest payments are exempt from state and local income taxes (but not federal taxes). This has the effect of increasing the after-tax benefits of these investments. Investors in high-tax states should take special note of this benefit.
Another important characteristic of the U.S. Treasury market is its high level of liquidity, which means that Treasuries are easy to buy and sell. Because they trade so frequently in large volume, the spreads between what a dealer would be willing to pay and what a dealer would be willing to sell for is lower than for other securities. Lower trade transaction costs and more efficient price discovery (determining the best possible price for buyers and sellers) result from such great liquidity in the U.S. Treasury market, benefits which are ultimately translated to the individual investor.