Three Smart Bond Strategies

Government bonds are kind of like the Bill Pullman character in Sleepless in Seattle — they stand for stability, not zest. But to reap the full benefit of dull dependability, you have to choose your Treasuries well. The wrong ones can rock your boat if the economy turns choppy.

Investing in government bonds is far from worry free. Sure, your principal and interest payments are guaranteed by the good old U. S. of A. The problem is maintaining your purchasing power over many years. Buy Treasuries with long maturities, and you’ll be riding high should inflation fall: With interest rates dropping around you, other investors will bid up the price of your bonds, producing a nice profit should you decide to sell. If inflation takes off, though, your principal won’t be worth a large pizza when you get it back. And in the meantime, your bonds will land you with a loss if you have to unload them early.

At the other extreme, putting your money in short-term T-notes protects you against hikes in inflation because you can roll them over to capture rising interest rates. But even when rates are rising, the interest you earn on your series of short notes may not equal what investing in one long T-bond brings in.

Three Smart Bond Strategies

1. The trick is to construct a debt portfolio that provides some of the benefits of locking in a long bond’s high coupon while reducing its potential for principal erosion and price swings. This can be done by steering a middle course, buying an intermediate-term bond or mixing longer and shorter maturities in a “barbell” or a “ladder.” Now is a good time to give the trick a try.
2. The simplest strategy is the “bullet”: just buying the five-year T-note. This provides more return than the two-year note with less risk than a long bond its price will move less drastically in response to interest-rate changes.
3. The other middle roads are a bit more complex. For instance, to construct a ladder, you buy equal amounts of 2-, 3-, 5-, and 10-year Treasuries. You thus have bonds maturing on a regular basis but still lock in part of your investment for 10 years. Building a barbell involves buying just two categories of bonds, at opposite ends of the maturity spectrum. You might purchase equal amounts of 2- and 10-year notes. Or you could split your money between 2- and 30-year maturities, putting three times as much into the short as the long term, to keep the interest-rate risk close to that of the five-year. In either case, if inflation rises, you are partially hedged, because you can roll over the two-years at higher rates. And if rates fall, you can count on the longer maturity to maintain your purchasing power for a while.