A guide to Treasury bonds
Editorial staff, J.P. Morgan Wealth Management
- Treasury bonds (or T-bonds) are securities that represent loans to the U.S. federal government. They are considered a low-risk investment because your capital is guaranteed with interest by the “full faith and credit” of the U.S.
- You can buy T-bonds directly from the U.S. Treasury, or you can buy them through your bank, a broker or via Treasury bond mutual funds or exchange-traded funds (ETFs).
- Beyond Treasury bonds, the U.S. Treasury offers four other Treasury marketable securities.
U.S. Treasury bonds are debt securities, issued by the federal government of the U.S. They are often considered a secure investment, since they are backed by the “full faith and credit” of the government.
In this article we’ll cover what Treasury bonds are, how they work, and the potential pros and cons of adding them to a portfolio.
What are Treasury bonds?
Treasury bonds (also known as T-bonds) are securities that represent loans to the U.S. federal government. Their sale helps fund the operations of the federal government. Because the government backs them, these securities may be considered “low-risk” by financial analysts.
Treasury bonds may play a key role in portfolio diversification, by offering protection against stock market volatility and by offering a steady source of income.
How do Treasury bonds work?
Treasury bonds are a type of government-backed security or loan. When you buy treasury bonds, the government uses that money to fund initiatives, for example, defense or infrastructure spending.
Treasury bonds are sold with maturity ranges of either 20 or 30 years. After purchasing, you’ll be paid a fixed interest rate every six months until the end of the maturity period. Once that period ends, you’ll receive the principal payment back.
It is possible to sell your bond before it matures as they’re bought and sold on secondary markets. Market conditions, like interest rates, will impact the bond’s value on secondary markets.
How do you buy Treasury bonds?
Investing in U.S. Treasury bonds can be done in a few different ways, depending on what works best for you. If you're looking to buy small amounts of Treasury bonds, you can purchase them directly from the U.S. Treasury.
If you want to buy larger amounts of Treasury bonds, you may want to work with a financial advisor to facilitate the purchase or you can purchase them through a bank or brokerage firm, including an online brokerage, yourself.
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Buying T-bonds from U.S. Treasury
As stated above you can purchase U.S. Treasury bonds directly from the government. You must make a minimum investment of $100, and purchases must be made in $100 increments.
Most investors when buying bonds directly participate in what is called a non-competitive auction process. The Treasury maintains a fixed schedule of auctions which investors can check on treasurydirect.gov. Those looking to buy Treasury bonds this way place a non-competitive bid before the auction date, and the order is filled at whatever rate is set. Payment is taken from the investor’s linked bank account. The interest rate received is determined at auction and is influenced by current market conditions.
Investors won’t be charged fees or commissions by buying Treasury bonds this way, though investors need a U.S. bank account, Social Security number and a U.S. address to do so.
Buying T-bonds from a bank or brokerage
You can purchase Treasury bonds on the secondary market through your bank or brokerage account as another option. This gives you more flexibility when it comes to choosing the maturity and coupon rate of your bond, but it can also come with additional costs compared to buying directly from the Treasury.
Investing in T-bonds via ETFs or mutual funds
Another option is to invest in Treasury bond focused ETFs or mutual funds. These are like baskets of Treasury bonds, and they offer a simple and low-cost way to get exposure to a diverse portfolio of Treasury bonds.
One drawback of investing in bond funds instead of buying bonds is that the value of the fund can fluctuate with the price of the bonds on the secondary market. If you hold Treasury bonds to maturity on the other hand, you’ll receive the full principal and interest as expected, regardless of market conditions.
The pros and cons of Treasury bonds
Like any investment, T-bonds offer a range of pros and cons potential investors should consider before committing to a purchase.
What are the advantages of purchasing Treasury bonds?
Besides offering the security of preserving your money (after the bonds mature you’ll get your initial investment back in full), Treasury bonds may offer these benefits:
- Considered low risk: Treasury bonds offer a fixed interest rate payment while being backed by the “full faith and credit” of the U.S. government.
- Stable income: The consistent interest rate payments allow investors to have a stable income stream.
- Tax benefits: Interest earned on Treasury bonds is exempt from state and local taxes.
- Diversification: Treasury bonds offer diversification as they are uncorrelated to equity markets and may help to reduce the risk in a portfolio.
What are the downsides of buying Treasury bonds?
While there may be several benefits to Treasury bonds, there are also certain risks to consider:
- Interest rates: Perhaps the largest risk to Treasury bonds is the fluctuation of interest rates. If rates increase, the market value of the bonds will decrease. While this is a risk, it can also serve as a benefit to the holder, as the bonds’ market value would increase should rates decrease.
- Inflation: It’s important to consider the rate of inflation relative to the yield a bond produces. Should the rate of inflation be high relative to a bond’s yield, the actual return would be low.
Other Treasury offered securities
Treasury bonds are not the only kind of security offered by the U.S. Treasury. Other types of Treasury marketable securities include the following:
- Treasury notes: These securities have a maturity of two to 10 years and also pay a fixed rate of interest semi-annually. They are considered to be a low-risk investment but with a shorter maturity compared to bonds.
- Treasury bills: Also known as T-bills, these have a maturity of less than one year and are sold at a discount from their face value. They do not pay a fixed rate of interest, but instead, the return is the difference between the purchase price and the face value. T-bills are considered to be the lowest-risk Treasury security.
- Treasury Inflation-Protected Securities (TIPS): TIPS are a type of Treasury security that provides protection against inflation. They have a fixed interest rate, which is adjusted based on changes to the Consumer Price Index (CPI).
- Floating Rate Notes (FRNs): FRNs are a type of Treasury security with a floating rate of interest that is reset semi-annually based on a benchmark rate.
- Series I bonds: These bonds are a type of inflation-protected savings bond that pay a fixed rate of interest, as well as a variable rate tied to inflation. The variable rate is adjusted every six months based on changes in the CPI for All Urban Consumers (CPI-U). Series I bonds are intended to help investors protect their savings from the effects of inflation.
- Series EE bonds: These bonds are a type of savings bond that pay a fixed rate of interest. Unlike Series I bonds, the rate does not adjust for changes in inflation. Series EE bonds are designed to provide a low-risk savings option for individuals, and they offer a guaranteed rate of return over the life of the bond.
The bottom line
U.S. Treasury bonds may offer a secure and reliable investment opportunity with attractive benefits. With fixed interest rates and semi-annual payments, Treasury bonds may offer a steady source of income over the long term. There are also downsides to these bonds to consider too, including the impact of inflation on the them and their restrictions.
If you're interested in investing in Treasury bonds, there are various avenues to explore. You can purchase them directly from the U.S. Treasury, or through a trusted bank or broker. You may want to consider speaking to a financial advisor to assess whether they are the right investment vehicle for your needs.
FAQs
You’ll owe federal income tax on the interest you earn from Treasury bonds, but you’ll be exempt from paying state and local income taxes.
When you initially purchase a Treasury bond, the price is set at face value. Interest rates and other market conditions affect resale value on the secondary market. Generally, there’s an inverse relationship between interest rates and T-bond prices. When interest rates fall, the value of existing T-bonds with fixed interest rates increases and vice versa.
They’re different primarily because each matures at different speeds. T-bonds mature after either 20 or 30 years. T-notes mature at rates ranging from two to 10 years. T-bills mature from four to 52 weeks. Interest is also handled differently. T-bonds and T-notes pay interest every six months, while T-bills are sold at a discount. The “interest” you earn is when the bill reaches face value after the maturation period.
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Editorial staff, J.P. Morgan Wealth Management
