The Risks of Long Term Treasury Bond Exchange Traded Funds

If you choose to invest in a bond exchange traded ETF,  you should know that bond ETFs are based on returns that track the underlying bond indices such as the one published by Lehman Brothers. The index returns for bonds are lower than stock index ETF like the S&P 500 or Russell 2000 indexes for stocks. The tradeoff between risk and return is what is always present when choosing to purchase a long term bond exchange traded fund ETF over other types of ETFs.

Who Needs Fixed Income ETFs?

Fixed income ETFs are more desired by investors with a limited investment period. They provide a safety feature similar to their underlying bonds. You should note that when investing in an exchange traded fund you are not actually investing in the underlying security but the performance of the index that tracks the security. This removes some of the investment risk associated with direct investing but not all of that risk. Any investment that you make entails the potential risk of loss and this should always be observed and accounted for whenever investing.

Risk/Reward Tradeoff

This downside is the tradeoff between safety and reward. The risk reward tradeoff is one of the principles of efficient portfolios, as discussed in the Modern Portfolio Theory. Creating a balance between assets that respond differently to market conditions produced a predictable rate of return by balancing inherent investment risks. Cash and instruments such as treasury bills are considered risk less investments and are used as a baseline to gauge the relative returns of other assets such as bonds (fixed income securities) and stock (equity securities) and more riskier investment asset classes such as oil, timber, and gold (commodities).

Expected Returns for Differing Asset Classes

If you were to expect a return of 10 to 12 percent for different subclasses of equities (which is close to the historical rate of return for large and small cap stocks according to Ibbotson Associates) you should only expect a long term return of 4 to 5 percent for fixed income securities such as treasury bills and treasury bonds respectively. With fixed income securities like bonds, the longer the duration of the bond the greater the volatility risk so the higher the return. This volatility risk associated with bonds however is nowhere near that for equities which can experience volatility risks that are twice that of fixed income securities.

That fixed income ETF (which merely track index performance and are not in it of themselves invested in the underlying security) have lower returns as a downside risk does not make them a bad place to invest. There are other factors to consider when purchasing a fixed income ETF such as holding period or duration of the investment and the investors goals and objectives for the investment.  

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