That isn’t a title that I thought I’d ever write. US Government Bonds are considered the gold standard (pun intended) of safe investments. America hasn’t defaulted on paying what it owes ever.
However, I’m starting to get concerned that, like all good things, this, too, may come to an end.
There are three things that I find unsettling about US government bonds right now.
- Tariffs
So far, it seems like tariffs aren’t that big of a deal. They were always going to take several months to work through the supply chain. However, many of them had been paused while negotiations happened. Still, others have been struck down in the courts and then reinstated on appeal while waiting for a full hearing. That’s my understanding, at least. They seem to be changing all the time on many different variables, so it’s pointless for me to speculate on where it will all end up.
The only underlying truth to all of it is that there is uncertainty. That uncertainty means that much of the economy is just waiting and seeing what happens. The Federal Reserve says it isn’t going to change interest rates because everything can change on a dime.
Many of the US bondholders are in foreign countries. Foreign countries view raising tariffs as an unfriendly act with the possibility of escalating into an all-out trade war. These foreign countries may sell their US bonds, making the decision that investing in the United States is not in their best interest during a trade war.
- National Debt
The national debt is higher than it has ever been. We pay about a trillion dollars in interest nearly every year. Compound interest is working against us. Our knowledge of basic personal finance tells us that it’s never a good situation to be in, right?
The House of Representatives has passed a budget to send to the Senate. The nonpartisan Congressional Budget Office has calculated that the increase the deficit by $2.4 trillion due to tax cuts and spending hikes for immigration enforcement. It would be a bigger deficit but cuts to Medicaid, and the Supplemental Nutrition Assistance Program (SNAP) save some of the deficit (at an obvious cost).
The budget is so bad for the national debt that Moody’s downgraded the United States credit rating saying:
“We do not believe that material multi-year reductions in mandatory spending and deficits will result from current fiscal proposals under consideration.”
In other words, they don’t believe the budget plan will lower the national debt. This isn’t really in the debate – I don’t think any politicians are publicly stating it will, either. When credit agencies (like Moody’s) deem that bonds are riskier, the rate may need to go up so that investors will buy them. A higher bond rate means that the US will pay more in interest. Paying more in interest increases the national debt further. Then, the cycle can repeat and grow bigger each time.
While the bill only has to be passed by the Republican majority, there is some resistance. It’s not quite clear if it’s enough resistance. My feeling is that with more than 95% of the Republicans pulling in the same direction, it’s just a matter of getting the last few on board. It’s interesting that Elon Musk has spoken out against it, and Republicans have been quick to turn on him.
To be fair, if this budget doesn’t pass, the tax credits that came in 2017 will expire, and Americans will experience what feels like one of the biggest tax hikes in history. That won’t reflect well politically on Republicans, either. People are more likely to notice paying more taxes and having less take-home pay than they are, a nebulous national debt number.
- Section 899 Taxing Foreigners
This part of the bill was overlooked and surprised a lot of people when they read it. As CNBC put it, US Foreign Tax Bill sends Jitters across Wall Street.
Essentially, this allows the United States to tax foreigners more if they feel like the countries aren’t taxing the US well. I could write a whole article about this, but the CNBC link above does a good job. It gets complicated, too. Essentially, it may discourage foreigners from investing in the United States and companies based in the United States. That’s not great for selling bonds or stockholders. Though taxing foreigners more would seem like a good way to lower the national debt above.
The good news is that not all of these things have to happen. The exception is that no matter what the budget that gets passed, we’ll still have a large national debt. The only question there is whether it’s going to grow much bigger. I feel like Section 899 and tariffs will largely go away eventually – or just be minor factors that the markets can adjust to.
Worknig With What I Can Control
I am an aggressive investor. I want as much of my money in the stock market for as long as possible to maximize compound interest. For this reason, I don’t have a lot of bonds. Currently, I have about 15% of my portfolio in bonds, and they are almost all in Vanguard’s Total Bond Market ETF (BND). To be brutally honest, I don’t research bonds too much. I had always assumed that the “Total Bond Market” would be very well diversified. Well, it has more than 68% US Government Bonds. That’s been great for a long time and may still be great for a long time, but I feel that BND isn’t the one-stop bond ETF for me anymore.
Instead of putting 100% of my bond allocation in BND. I’m going to put 1/3rd into it. Another 1/3rd is going into iShares Core US Aggregate Bond ETF (AGG). That has only 45% US Treasury Bonds, with the next 11% being Federal National Mortgage bonds. The rest of the holdings are all US-based as well. The last 1/3rd is going into Vanguard Total International Bond ETF (BNDX). That diversifies across many countries throughout the world.
In the long run, this is unlikely to make a huge difference in my portfolio’s performance. It’s a small part of the portfolio, and the diversification may not be necessary. It is also intended to be mostly a safe place to earn a return that’s a little better than cash.
The bigger reason why I am making the change is that it makes me feelsafer with this portion of my portfolio. The main benefit may be psychological.
What do you think? Am I overthinking things? Let me know in the comments.
The post I’m Diversifying Away From US Government Bonds appeared first on Lazy Man and Money.