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Investing in America

Published: July 26, 2010

As the great stock market debacle of 2008 fades oh-so-thankfully into memory, the real takeaway message for investors is that diversification is crucial. More specifically, when stocks stumble—yes, that will happen again at some point—you want to be holding bonds. And the bonds most worth holding are those backed by the full faith and credit of the United States government, otherwise known as Treasuries.

Susan Ellis, 78, a retired U.S. Department of State worker residing in Washington, D.C., lives partly on a pension and partly from her savings. Those savings are half in stocks and half in bonds, with the lion’s share of those bonds being Treasuries. While Ellis’ stocks sagged in the recent recession, her Treasuries more than held their own. “Having part of my portfolio in U.S. government bonds provides me with great comfort,” says Ellis. “It helps me to sleep at night.”

Treasuries give many investors similar peace of mind. “When there is fear and turmoil in the markets, people seek safety; Treasuries fulfill that role admirably—and they always have,” says Christopher Philips, a senior analyst with the Investment Strategy Group at Vanguard Investments. Indeed, during this past recession, Treasury bonds were the only place to seek safety, adds Philips. “U.S. stocks were down, so were foreign stocks, real estate, and corporate bonds … every kind of major investment lost value, except for Treasuries.”

According to data from Morningstar, while U.S. stocks fell in value 46 percent between October 2007 and March 2009, long-term Treasuries rose by 25 percent. In the recession prior, between March 2000 and September 2002, U.S. stocks fell by 38 percent, while long-term Treasuries soared 40 percent. This zigzagging pattern of returns between stocks and government bonds has existed for decades, which is why smart investors, wanting to dampen volatility in their portfolios, own Treasuries.

The “catch” with Treasuries—in fact, all bonds, but especially Treasuries—is that they produce modest returns over time. Since 1926, per Morningstar data, stocks have returned 9.8 percent a year, while long-term Treasuries have generated 5.4 percent. If you mixed-and-matched, combining 60 percent stocks with 40 percent Treasuries, the average yearly gain of your portfolio would have been 8.6 percent.

To make Treasuries a part of a balanced portfolio, consider this:

  • The first step in constructing a portfolio is to determine what portion you want in stocks and what portion bonds. The higher the return you desire, and the more volatility you can stomach, the more you want in stocks. Important note: Bonds in the past 20 years have done exceptionally well (see chart on page TK), but the relative return on bonds to stocks may revert to long-term norms, says Philips. “Treasuries have done very well in the past 20 years because bonds tend to shine when interest rates fall … but when rates rise, bonds tend to not fare as well.”
  • Whatever your allocation to bonds, consider putting roughly 40 percent of that into conventional Treasury bonds, recommends Philips. The rest could be in corporate bonds (which tend to return slightly more than Treasuries), municipal (tax-free) bonds, foreign bonds, or inflation-protected Treasury bonds (discussed below).
  • Treasuries, like all bonds, may be purchased with various maturities: short-term, intermediate-term, or long-term. In general, the longer the maturity, the higher the return, but the greater the price swings. Philips recommends that you shoot for the middle—“intermediate-term” bonds that mature in about seven years.
  • You can buy individual U.S. Treasuries, free of trading costs, by going to Treasurydirect.gov. Or, you can buy a fund of Treasuries, which allows for instant diversification of maturities and ease of management. Choose a fund with low costs. Options include the SPDR Barclays Capital Intermediate-Term Treasury fund (ticker symbol ITE) or the Vanguard Intermediate-Term Treasury fund (VFITX).
  • Add TIPS. Treasury Inflation-Protected Securities (TIPS) are a different breed of Treasury that offers little interest, but is adjusted for inflation twice a year. Consider allocating a part of your bond portfolio above and beyond conventional Treasuries to TIPS, suggests Philips. Like conventional bonds, TIPS can be purchased individually through Treasurydirect.gov or as a fund. Options include the Vanguard Inflation-Protected Securities fund (VIPSX) or the iShares Barclays TIPS fund (TIP).

Whichever way you decide to go to buy Treasuries, once you do, your sleep, like Ellis’, will likely improve, too.

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