If you remember bond drives in school, please raise your hand. There are still a lot of us out there. I recall my teacher holding up a US Savings Bond, encouraging us to tell our parents to buy them. She went to great lengths emphasizing that they were the “the safest investment on earth.”
That same teacher gave us ten new words each week that we had to spell and define. “Safe” and “risk” both had their day. Here is how Merriam-Webster defines them:
safe
adjective sÄf
: not able or likely to be hurt or harmed in any way : not in danger
: not able or likely to be lost, taken away, or given away
risk
noun risk
: the possibility that something bad or unpleasant (such as an injury or a loss) will happen
Safety is the absence of risk. When we lived in Texas, we had to take our cars in for a safety inspection. The inspector would hook up a computer and out came a checklist of items with a pass or fail mark. It’s time to do a safety inspection for those high-quality bonds considered “the safest investments on earth.”
Risk #1: Default. The risk that a loan won’t be repaid is the primary risk when lending money to anyone. When it comes to bonds, rating agencies judge that risk for you. The safest way to lend—in terms of getting your money back, anyway—is with federal government bonds or certificates of deposit, which are federally insured.
Corporate bonds are rated with a series of letters beginning with AAA. Anything below the B-ratings are generally not considered investment grade and are commonly referred to as junk bonds. If an investor sticks to AAA bonds, they will earn a little higher interest than they would with US Treasuries to make up for the increased default risk; however, that risk is very low, generally less than 0.5%, on average.
A person buying a US government bond or AAA corporate bond has close to a 100% probability of being paid back with interest. Check off the first item on the inspection sheet. PASS!
Risk #2: Inflation protection. The interest rates paid by a bond (net after income taxes), must be higher than the inflation rate throughout its life. If not, when our principal is returned and added to the interest received, our buying power will be less than it was before we bought the bond. How big of a risk can that be?
