What Makes an Asset "Safe"?

Happy Sunday

Imagine two bonds with exactly the same safety level, but one pays higher interest. Which would you pick?

The obvious answer is the higher-paying one. Here's the strange part: millions of investors consistently choose the lower-paying bond instead.

This happens because "safe" means different things to different people. What feels safe to a bank might feel risky to your neighbor, and vice versa. Recent data from the pandemic era in the EU proves this creates real profit opportunities for investors who understand the psychology.

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The European Case Study

During COVID, Europe needed to borrow money fast. They created two types of bonds:

Type 1: Backed by Germany alone
Type 2: Backed by Germany AND 26 other European countries (EU)

Logic says Type 2 should be safer - more countries backing the same debt. But here's what's weird: Type 2 bonds pay higher interest rates than Type 1.

Why? Because of identity. People see themselves as German citizens or Dutch citizens. They have flags, national anthems, shared history with these countries. When Germans buy German government bonds, they're supporting "their" government.

But nobody wakes up feeling proud to be a "European Investment Bank stakeholder." The EU is an institution, not an identity. So individual investors instinctively choose bonds from countries they identify with - even if it means earning less.

Big banks and investment funds don't have this emotional attachment. They just see the math: more backing = lower risk = better deal at higher yields.

The result: A permanent two-tier market where identical safety gets priced differently based purely on emotional connection. Individual investors accept lower returns to feel patriotic. Institutions collect extra yield for being logical.

The Same Thing Happens Right Here in the United States

This psychological pricing exists all over US markets.

Government bonds vs. Municipal bonds: During market stress, regular investors flood into US Treasury bonds because they feel "guaranteed by America." Meanwhile, smart money buys high-quality municipal bonds (issued by states and cities) that often pay better after-tax returns with virtually the same safety. Both are government-backed, but one feels more "American."

Treasury bonds vs. Fannie Mae/Freddie Mac bonds: Fannie Mae and Freddie Mac are government-sponsored companies that the government explicitly backs. Their bonds should be just as safe as Treasury bonds, but they pay higher yields because investors prefer the "full faith and credit of the United States" label over corporate names they don't fully understand.

Bank CDs vs. Treasury bills: Your local bank CD is backed by FDIC insurance - literally the same government backing your Treasury bills. But people trust their bank more than a government bond, so they accept lower yields for the familiar "bank account" feeling.

Corporate bonds from safe companies: Many large corporations (like Microsoft or Johnson & Johnson) are arguably safer than some foreign governments, yet their bonds pay higher yields than Treasury bonds simply because investors tend to think "government = safe, corporation = risky."

The pattern is always the same: when two investments have almost identical safety but different emotional appeal, one pays more than the other. Smart investors collect these extra yields by choosing the mathematically better option over the psychologically comfortable one.

What the heck am I getting at? 

"Safety" isn't objective - it's personal. And that creates profit opportunities for those willing to think differently than the crowd without having to take more theoretical risk.

- John

This analysis reflects Pivot and Flow’s views and isn’t personalized advice. All investments carry risk, including complete loss of principal.

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