Previously we’ve discussed how you should choose the minimal risk asset  that will form the bedrock of your portfolio. The short version: If you have high-rated government bonds available in your base currency, they will typically be the best choice.1 
Today we will look at the time horizon of your minimal risk investment, what returns you can expect to make, and how best to buy it.
Match the time horizon
In most discussions about minimal risk investments, the assumption is you’re talking about short-term bonds. Longer-term bonds have greater interest risk (i.e. they fluctuate in value with changes in the interest rate), and it’s not clear that all investors need to take that risk.
Consider a one-month zero-coupon bond and a 10-year zero-coupon bond that both trade at 100. (Zero-coupon bonds  are a particular kind that don’t pay interest, only the principal back at maturity).
Suppose market interest rates suddenly go from zero to 1%. What happens to the value of these bonds?
As you can see, the one-month bond declines only a little in value to reflect the higher interest rate of 1%. This bond matures in just a month, and at that point the bond holder will be able to reinvest their principle at higher prevailing rates if they want to.
In contrast, the 10-year bond declines to a value of around 90.5 as it reflects the higher interest rate. Clearly something that can go from 100 to 90.5 fairly quickly is riskier – even if the probability that you will eventually be paid in full has not changed.
The time horizon for the vast majority of investors exceeds the maturity of a short-term bond, however. Also, someone who is interested in maintaining a position in the minimal risk asset for five years will be taking an interest rate risk over that five-year time horizon, whether they’re buying new three-month bonds every three months, or buying a five-year bond and holding it to maturity.
Finally, the situation is dynamic. If your time horizon is such that you think five-year bonds make sense, you shouldn’t necessarily just buy a five-year bond and hold it to maturity. A year hence, your bond would only have four years to maturity and therefore no longer match your time horizon.
The best way to address these issues is not for you to constantly buy and sell bonds to get the right maturity profile (in my example selling the now four-year bond and buying another five-year bond), but rather to invest in the bonds through a product like an ETF or investment fund that trades the bonds for you.
Such funds offer exposure such as ‘Germany 5–7 years (to maturity) government bonds’, ‘UK 10–12 year government bonds’, and so on. Buying one or a couple of these products to match your desired minimal risk asset and maturity profile is a cheap and easy way to ensure you always have your chosen minimal risk exposure.
Investors with a longer time horizon should buy longer-maturing minimal-risk bonds. As a reward for taking the interest rate risk associated with longer-term bonds, you’ll typically enjoy a higher return than you’ll get from short-term bonds.2 
Go longer to reflect your investment horizon
If you need a product that will not lose money over the next year, then you can pick short-term bonds3  that match your profile.
However if – like most people – you want a product that will provide a secure investment further into the future, choose longer-term bonds and accept the attendant interest-rate risk.
Here you should consider the time horizon of your portfolio and select the maturity of your minimal risk bonds accordingly.
If you are matching needs far in the future (such as your retirement spending) then there is certainly merit in adding long-term bonds or even inflation-protected bonds to your portfolio.
Long-term bonds compensate investors for interest-rate risks by offering higher yields. You also have the further benefit of matching the timing of your assets and needs.
You can also mix the maturities of your minimal risk assets. You may have some assets that you won’t need for decades, and others you think will be needed in five to seven years, say. In that case, there is nothing wrong with picking a couple of different products with different maturities to match that profile.
What will the minimal risk bond earn you?
Even people with only a peripheral interest in finance know that interest rates are near historical lows. Nobody should expect to make a lot of money investing in the minimal risk asset in any currency right now.
In fact, with nominal interest rates near zero, inflation means that investors in short-term government bonds will experience negative real returns.
While your $100 invested in a government bond will almost certainly become $105 in five years’ time, the purchasing power of that $105 will be less than that of your $100 today. This is, of course, still better than if you had held the $100 under the proverbial mattress for five years – in that case the purchasing power would be even lower.
There’s not a lot you can do about this. If you are after securities with minimal risk then the yields are just very low at the moment. At the time of writing, cash with FSCS  protection may be a better option for private investors, as we discussed last time . (Over the long term, returns  from cash have historically been lower than from bonds, on a market wide view).
Elsewhere, instruments that offer much higher returns come with more risk of not getting paid. Anyone who tells you otherwise is not telling you the whole story.
The chart above shows what US government bonds (so in $) will currently earn you, by maturity, both in real and nominal terms (you can easily find it for other currencies if you Google ‘£ Government bond yield curve’, and so on.).
You can see, for example, that if you buy a 20-year US government bond, you can expect to earn just under 1% real return per year . Likewise, for a five-year bond you can expect just over a zero percent real return per year. (Five-year US government bond returns yields have actually been negative for much of the recent past.)
While the outlook for generating very low-risk real returns is fairly limited at present, these are continuously moving markets. Keep an eye on them as rates change.
Nominal yields, real yields, inflation, and taxes: The previous chart also shows you the current market expectation for future inflation. (It’s the difference between the two lines.) If the markets are assuming there will be roughly 3% annual inflation in the US for the next 25 years but only around 2% for the next five years, this suggests higher inflation in the longer term. Inflation is bad for many things, one of which is tax. While the benefits you get from your investments are based on real returns and the future purchasing power of your money, you pay taxes on the nominal return. Suppose you invest $100 for a nominal return of 2% the following year. You could be liable for tax on your $2 gain, even if 2% annual inflation had eroded the real gain4 . Compare that to a zero inflation rate environment. With a 0% nominal and real return, your $100 would still be $100, both in real terms and nominally, at the end of the year. And there would be no gains to be taxed on!
If the previous chart gave you the sense that the return you’ll get in any one year from owning US government bonds is stable, reconsider.
The next chart shows the annual return from holding very short-term (less than one year) and long-term (more than ten years) US bonds since around the Depression.
As you can see the annual returns move around a fair deal for both kinds of bonds – but far more for the long-term bonds. This is because such bonds will move in value much more as the interest or inflation rate fluctuates.5 
Some takeaways from the two graphs:
- Real return expectations from these minimal risk assets are currently near historic lows.
- Returns from these minimal risk assets have fluctuated quite a bit, because of changes in inflation and real interest rates, and can reasonably be expected to do so in the future.
- You can generally expect higher returns from investing in longer-dated bonds. If that matches your investment horizon, then hold your minimum risk bond portfolio through an ETF or index fund. But be prepared that particularly for longer-dated bonds, the yearly fluctuations in value can be significant.
Buying the minimal risk asset
Because of the costs involved in trading bonds, most investors in short-term bonds have to accept that in most cases the bonds in their portfolios will not be super short term6 , and that you will be taking a little bit of interest rate risk as a result.
The most liquid short-term bond products like ETFs or index funds have average maturities of 1–3 years. The slight interest rate risk that comes from holding such bonds is a reasonable compromise between the theoretical minimal risk product and one we can actually buy in the real world.
For most investors with longer-term investment horizons, there are funds with different ranges of maturities like 5–7 years, 7–10 years, and so on, to suit your preferences.
How much of the minimal risk asset you should have in your portfolio and what maturities it should comprise depends on your circumstances and attitudes towards risk .
If you’re extremely risk averse, you might put your entire portfolio into short-term minimal risk assets, but you should not expect much in terms of returns. As you add more risk – mostly by adding equities  – your potential returns will increase, and vice versa.
Varying the amount of minimal risk asset you hold in your portfolio adjusts the risk profile.
In the simplest scenario, where you only choose between the minimal risk asset and a broad equity portfolio , you could weigh the balance of those two according to the desired risk. The minimal risk bonds would have very little risk, whereas the equities would have the market risk. How much risk you want in your portfolio would be an allocation choice between the two (in a future post I will discuss adding corporate bonds).7 
For some investors, putting 100% of their money in the minimal risk asset is their optimal portfolio. This would be appropriate if you are unwilling to take any risk whatsoever with your investments – and if you accept this means very low expected returns!
- If your base currency has government bonds of the highest credit quality (£, $, €) then those should be your choice as the minimal risk asset.
- If your base currency does not offer minimal risk alternatives, you have the choice  of lower-rated domestic bonds where you take a credit risk, or higher-rated foreign ones where you take a currency risk. Keep in mind that any domestic default would probably happen at the same time as other problems in your portfolio, and your domestic currency would probably devalue. That would render foreign currency denominated bonds worth more in local currency terms.
- If you want the lowest risk you should buy short-term bonds. If you have a longer investment horizon, then match the maturity of your minimal risk bond portfolio with your time horizon. You will have to accept interest rate risk, even if you avoid inflation risk by buying inflation-linked bonds .
Video on your low risk portfolio allocation
Here’s a video that recaps some the things I’ve discussed in this article. You will also find other relevant videos on my YouTube  channel.
- Private investors may also want to consider cash as part or all of their minimal risk asset allocation. Please see my previous article  for more details. This article will focus on the traditional minimal risk building block – high rated government bonds. [↩ ]
- There are cases where the yield curve is reversed and shorter-term bonds yield more than longer-term ones, but these cases are less frequent. [↩ ]
- Or cash. See the previous article on the minimal risk asset. [↩ ]
- i.e. The purchasing power a year hence would still be $100 in today’s money even if the nominal amount had become $102. [↩ ]
- The market view of credit worthiness will also have played a role. [↩ ]
- Imagine the scenario where you want to hold one-month government bonds. Tomorrow the bonds are no longer one-month to maturity, but 29 days. Is this ok? How about 2 days hence? How much you are willing for the maturity to deviate from exactly 30 days is up to you, but in reality there is a trading and administrative cost associated with trading bonds. It would simply not be feasible to stay at exactly 30 days to maturity at all times. [↩ ]
- Certain corporate bonds trade with lower risk premiums than many governments. The view is that these corporate bonds are lower credit risk than many governments – not hard to believe – and although they do not have the ability to print money, nor do governments in the eurozone. The reason I believe that you should not consider these bonds as the minimal risk asset is more practical. Compared to government bonds, the amount of corporate bonds outstanding for any one company is minuscule and you would probably not be able to trade them as cheaply and liquidly as government bonds. [↩ ]