Government BondsBond Instruments
Government bonds, also known as Sovereign Bonds, are issued by governments to fund projects and are repaid with taxpayer dollars. Any nation state can issue its own government bonds if needed. Government bonds are normally covered with the “full faith and credit” of the particular government issuing the bond. This statement means the government must take full advantage of its ability to issue currency and tax its population in order to pay their debts. Some sovereign states cannot issue currency. Eurozone Nations, which rely on Euros but cannot print currency since they lack control of the European Central Bank, are an example. To encourage investors to purchase bonds, some governments issue bonds which are immune to provincial, state, or local taxation. Check with your national government to ensure your government’s bonds allow taxation immunity from regional, provincial, or municipal taxes.
Due to the ability to tax and print currency as payment for bonds, sovereign issued bonds are amongst the safest investments in the world. They are also incredibly resilient against financial crisis and have low correlations to returns in the market and economy. As a downside, the reward for low risk is equally low returns. To add insult to injury shorter term government bonds return even less. The low returns from government bonds are a major reason you should never put a large percentage of your portfolio into government bonds. They should be used to stabilize your portfolio, but you should not put high percentages of your portfolio into sovereign issued bonds. They are mostly for preservation of capital, not growth.
Purchasing government bonds is usually simple, depending on the nation. Most nations allow you to purchase fresh issues directly via internet or phone, skipping the secondary market. There should be little to no charge compared to using a broker to purchase government bonds. Some nations, such as the United Kingdom, have an auction style direct purchase for their fresh issues. If you are purchasing from the secondary market, sovereign markets are usually highly efficient, and deals on both buy and sell side are not easily found. Bond funds specializing in a single nation’s issues are unnecessary for the purchase of government bonds. Since the bonds within a nation are all issued from the same place, diversifying by issuer is no longer relevant. A bond fund’s only real benefit is providing you management and bond laddering which you do not have to do yourself. International sovereign bond funds can offer a diversification benefit in addition to these advantages.
Lastly, government bonds come in two primary flavors. Sovereign Issued Nominal Bonds are not adjusted to inflation and function normally, giving you interest from the basic par value which remains static. Inflation Adjusting Bonds change the par value based on inflation first, and then calculate interest from the inflation adjusted value. After separating into these primary classifications, bonds separate into their normal long term versus short term selections.
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