T-Bond

T-Bond (also known as the Treasury Bond) is a long-term, superstar bond issued and guaranteed by the U.S. Department of the Treasury. Think of it as lending money to the U.S. government for a very long time—typically 20 or 30 years. In return for your loan, Uncle Sam promises to pay you interest every six months, known as a coupon payment, until the bond's maturity date. When it matures, you get your original investment, the par value, back in full. Because they are backed by the “full faith and credit” of the U.S. government, they are considered one of the safest fixed-income securities on the planet. This safety makes them a cornerstone for conservative investors, pension funds, and foreign governments looking for a secure place to park their cash. However, as we'll see, safe doesn't mean risk-free.

Imagine you buy a 30-year T-Bond with a face value of $1,000 and a coupon rate of 4%. Here’s what happens:

• You lend the U.S. government $1,000 (though you might buy it for slightly more or less than this on the secondary market).
• The government pays you 4% of $1,000, which is $40, every year. This is usually paid in two semi-annual installments of $20 each.
• This continues for 30 years. You'll collect a total of $1,200 ($40 x 30) in interest over the life of the bond.
• At the end of the 30 years, the government returns your original $1,000.

It's a simple, predictable stream of income from the world's most creditworthy borrower. You won't get rich quick, but you can be pretty certain you'll get paid.

The U.S. Treasury issues a whole family of debt, and the main difference is their lifespan:

• T-Bills (Treasury Bills): The babies of the family, maturing in one year or less. They don't pay a coupon; you buy them at a discount and get the full face value back at maturity.
• T-Notes (Treasury Notes): The middle children, with maturities ranging from two to ten years. Like T-Bonds, they pay interest twice a year.
• T-Bonds (Treasury Bonds): The wise old elders, with maturities of 20 or 30 years. They are the most sensitive to changes in long-term interest rates.

For a value investor, every asset must be judged on its price and its contribution to a sound portfolio. T-Bonds are no exception. They aren't tools for spectacular growth but are masters of defense and stability.

The legendary value investor Benjamin Graham advocated for a balanced asset allocation between stocks and bonds to protect investors from their own emotional decisions and the market's wild swings. T-Bonds play this defensive role perfectly. When stock markets panic and tumble, investors often flee to the safety of T-Bonds, pushing their prices up. This “flight to safety” can cushion the blow to your overall portfolio during a crisis. Their predictable income stream also provides cash flow that can be used to buy stocks when they are cheap—a classic value investing move. As Warren Buffett has often noted, the first rule of investing is “Don't lose money,” and holding high-quality bonds is a key part of that strategy.

While you won't lose your principal if you hold a T-Bond to maturity, you can certainly lose purchasing power or see the market value of your bond drop.

• Interest Rate Risk: This is the big one for T-Bonds. Let's say you own a 30-year bond paying 3%. If the Federal Reserve raises interest rates and new bonds are issued paying 5%, nobody will want to buy your 3% bond for its original price. Its market price will fall to make its yield competitive with the new bonds. The longer the maturity, the more sensitive the bond's price is to these changes. A value investor must understand that buying a long-term bond is a big bet on where interest rates are heading.
• Inflation Risk: Your T-Bond's coupon payments are fixed. If inflation suddenly surges to 5%, your 3% bond is now delivering a negative “real” return of -2%. Your money is losing purchasing power every year. For investors deeply concerned about this, Treasury Inflation-Protected Securities (TIPS) are an alternative, as their principal and interest payments adjust with inflation.

A T-Bond is a good value when the compensation (its yield) is attractive for the risk you're taking. A value investor doesn't just buy them because they are “safe.” They compare the T-Bond's yield to other opportunities. For instance, is the guaranteed yield from a 30-year T-Bond more attractive than the potential (but uncertain) earnings yield from the stock market? When T-bond yields are very low (meaning their prices are very high), a value investor might conclude they offer poor compensation for locking up money for 30 years and taking on significant interest rate and inflation risk. Conversely, when yields are high, they can represent a compelling, low-risk alternative to an overpriced stock market.

The 30-year T-Bond, often called the “long bond,” has had a rocky relationship with the U.S. Treasury. It was discontinued in 2001, with the Treasury citing reduced financing needs and a desire to consolidate debt into shorter-term securities. However, after a five-year hiatus and demand from pension funds and other long-term investors, the Treasury brought the 30-year T-Bond back from retirement in 2006, and it has been issued regularly ever since.