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Treasury Bonds: The Risks in Avoiding Risk

We've heard that it's impossible to be too rich or too thin. What about too safe? It's been hard to imagine that lately, during the worst stock market in decades, but the multitude of investors seeking refuge in government bonds may be displaying an imprudent amount of prudence.

Massive buying of what are seen to be among the few risk-free assets left in a risky world recently pushed yields on Treasury bonds and similar paper to six-decade lows. Yields rebounded until mid-March and then sank anew when the Federal Reserve said it would spend hundreds of billions of dollars on Treasury instruments and mortgage debt.

A bright idea, especially in the markets, can dim markedly if it pops into the heads of enough thinkers. That may have happened with Treasury bonds.

"People confuse certainty and safety," Harold Evensky, a financial planner at Evensky & Katz in Miami, told me recently. Buyers of Treasuries at such high prices -- bond prices rise as yields fall -- "are certain they'll get their money back, but it's certain that it will buy less when they get it back."

What makes him certain of that is the large amount of money being created by the Fed to dole out to failing banks. He and others expect that to lead to higher inflation one day.

If so, Treasury debt -- the yield on the 10-year bond fell to just above 2 percent in December and was recently around 2.4 percent -- would be a poor store of value. Income would be paltry, and anyone selling before maturity would run the risk of taking a capital loss on the supposedly risk-free asset.

Mark Mobius, executive chairman of Templeton Asset Management, goes so far as to invoke the B word to describe the overbooked flight to safety. "What I'm seeing is the printing press in Washington working overtime," he said. "In that kind of environment, we're having a Treasury market bubble because people think it's a safe place to be. I disagree."

T-bonds are not a bad deal for everyone in the market, said another expert I talked to, Brett Hammond, chief investment strategist at TIAA-CREF. "The feds love this," he said. "They'll issue all the debt they can right now."

As volatile as other investments may be, Hammond advises thinking twice before letting them issue any to you. "It's possible to put yourself in a position where you're not keeping up with inflation and paying the feds to take care of your money," he said. "There are better opportunities out there." He likes high-grade corporate bonds. Companies' creditworthiness has tanked with the economy, but he finds the threat of default much lower than yields are pricing in.

Mobius prefers commodities and stocks "to protect us from coming inflation."

Evensky suggests rebalancing portfolios by selling bonds and buying stocks. While T-bonds are widely considered safe but have risks that investors are failing to factor in, the stock market is less risky than it seems, in his view.

"Investments perceived as risky are more likely to be the most attractive investments going forward," he said. Misunderstanding past weakness for present risk "is typically why investors buy high and sell low."

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