Key Takeaways
- Treasury bonds are long-term debt securities issued and backed by the U.S. government.
- When you buy a Treasury bond, you are loaning money to the federal government. In exchange, you receive interest payments every six months until the bond matures. The payments are referred to as coupons.
- Since Treasury bonds are backed by the federal government, they are considered risk-free investments. But there are some downsides to consider, since your money is tied up for 10 or more years.
What Are Treasury Bonds?
Treasury bonds are a type of long-term debt security issued by the U.S. Department of the Treasury as a way to finance the federal government’s operations. When you purchase a Treasury bond, you become the bondholder, and the government is the borrower.
As the bondholder, you receive fixed-rate interest payments (called coupons) every six months on the amount loaned (known as the par value). These payments continue until the bond reaches maturity. Once the Treasury bond reaches its maturity date — typically after 10 or more years — the debt is repaid in full.
Since Treasury bonds are issued by the U.S. government, there is little risk of default. That’s why Treasury bonds are considered the safest type of investment. Unlike corporate bonds, Treasury bonds have no credit risk, are extremely liquid and benefit from tax advantages at the state and local level.
How Treasury Bonds Work
To understand the basics of how Treasury bonds work, let’s look at this example scenario:
- You purchase a Treasury bond with a par value of $10,000 on Aug. 15, 2023.
- The bond has a 20-year term, which means it will mature on Aug. 15, 2043, the day the par value gets repaid in full.
- The coupon rate is set at 4.00%.
- Coupon payments will be made semiannually on Aug. 15 and Feb. 15, with the first payment scheduled for Feb. 15, 2024.
Based on this information, you can estimate the coupon payment using this calculation:
You’ll receive $400 in interest income every year from this Treasury bond. If you hold the bond until its maturity date (Aug. 15, 2043), you will have received $8,000 of interest over the entire term, plus the return of your initial $10,000 investment.
What Are the Differences Between Treasury Bonds, Notes and Bills?
Treasury bonds often get lumped together with Treasury notes and Treasury bills, but they’re not all the same. The main difference is their term length, or how long it takes for the loan to mature. Below are the three types of Treasury securities and their key differences:
- Treasury bills have maturity dates between 30 days and one year and are structured as zero-coupon instruments, which means they don’t pay any interest until maturity. Instead of interest payments, investors are compensated by receiving more than their initial investment once the bill matures.
- Treasury notes have maturities between two years and 10 years and make coupon payments every six months.
- Treasury bonds have maturities longer than 10 years and make coupon payments every six months (semi-annually). The longest term is typically 30 years, but in recent years they’ve been known to go longer.
In addition to bonds, notes and bills, the U.S. Department of the Treasury also issues Treasury Inflation-Protected Securities (TIPS), which offer a return that fluctuates with the rate of inflation, as well as different types of U.S. savings bonds.
Treasury bonds are safe investment to consider when trying to balance your portfolio. Consider Treasury bill and notes also, as they have shorter maturity dates, when balancing your portfolio.
Timothy Li, MBABusiness Finance ManagerTimothy Li, MBA, has dedicated his career to increasing profitability for his clients, including Fortune 500 companies. Timothy currently serves as a business finance manager where he researches ways to increase profitability within the supply chain, logistics and sales departments.
How Are Treasury Bond Rates Determined?
Treasury bond rates can fluctuate based on supply and demand, interest rates and inflation. You can see the current Treasury bond rates on TreasuryDirect.
Generally, the longer the term length of the Treasury bond, the better the return (since the investor is taking on more risk). However, supply and demand imbalances can push a bond’s interest rate higher or lower than expected, which can result in unusually shaped yield curves.
What Are the Benefits of Investing in Treasury Bonds?
Since U.S. Treasury bonds are backed by the federal government, they are considered the safest type of bond investment. If you hold onto your Treasury bond until it matures, your debt will be repaid in full, which means there is no risk to your credit.
If you need to access your funds sooner, you can easily sell your Treasury bond on the secondary market before it reaches maturity. This benefit of Treasury bonds is known as liquidity.
Additional benefits of Treasury bonds include tax advantages — the interest you earn over time is exempt from state and local income tax. Moreover, Treasury bonds provide a predictable source of fixed income and serve as a stabilizing force in an investment portfolio.
Despite all the advantages, Treasury bonds are not totally risk-free. They are not recommended if you have a long investment horizon, since your money may grow faster in a different type of investment with a higher rate of return, such as stocks or real estate. Treasury bonds can also be highly sensitive to interest rate changes.
How Do Treasury Bonds Compare To Other Investments?
Treasury bonds are similar to other long-term debt securities like municipal bonds, corporate bonds and U.S. government agency bonds, such as those issued by Fannie Mae and Ginnie Mae.
Like Treasury bonds, these types of bonds provide a reliable source of fixed income with a relatively high degree of liquidity, meaning you can sell your bond before it reaches maturity and recoup your investment early.
The key difference between these types of bonds is the potential for default. Treasury bonds are safer than any other long-term debt security, as there is no risk of default. But you will likely see higher rates of return with riskier bonds, as investors are compensated for the additional risk.
As for the tax advantages, Treasury bonds aren’t as ideal as tax-exempt municipal bonds, which are exempt from federal income tax as well as state and local income tax if you purchase the bond in the state where you live. Given this favorable tax treatment in terms of your personal finance situation, tax-exempt municipal bonds generally pay lower interest rates than other similar Treasury bonds.
How Do I Start Investing in Treasury Bonds?
You can invest in Treasury bonds in two ways: via the primary market or the secondary market. To buy bonds in the primary market, you’ll pay cash to the U.S. government and receive a Treasury bond in return.
In the secondary market, a bank, broker or dealer must buy a previously issued Treasury bond from another trader.
Where Do You Buy Treasury Bonds?
The easiest place to buy Treasury bonds is through TreasuryDirect, a website associated with the U.S. Department of the Treasury. Once you create a TreasuryDirect account, you can buy bonds for as little as $100. You can purchase additional bond amounts in multiples of $100, and there is no limit to the number of bonds you can buy. Banking institutions, brokers and dealers can also purchase Treasury bonds on your behalf, and they have the added ability to buy bonds at auction prices.
You can also choose to buy Treasury bonds through the secondary market, which is where investors trade previously issued Treasury bonds with one another. To buy and sell in the secondary market, you must go through a bank, broker or dealer.
In many cases, you can gain exposure to Treasury bonds by investing in index mutual funds and exchange-traded funds (ETFs). Two examples are Fidelity’s Series Long-Term Treasury Bond Index Fund (FTLTX) and iShare’s 20+ Year Treasury Bond ETF (TLT). When you invest in an index mutual fund or ETF, the earnings are spread across all shareholders, as you’re buying an underlying basket of Treasury bonds. The funds then make periodic interest payments to all shareholders.
Are Treasury Bonds a Good Investment?
At face value, Treasury bonds are neither inherently good nor bad investments. When you’re deciding if Treasury bonds make sense for your financial situation, you’ll need to consider your investment goals and a few market conditions.
Treasury bonds are usually a good investment if you’re looking for a stable source of reliable, long-term income with minimal interest rate risk. On the flip side, Treasury bonds are a poor choice if you have plenty of time (and money) to invest in funds with a higher rate of return. For you, the opportunity cost of not investing in higher-returning stocks and other assets is simply too great.
But of course, Treasury bonds are just one of many investment options to choose from. You should consider your entire investment portfolio before making your decision, as Treasury bonds can provide the benefit of diversification.
To assess your specific situation, consult with a fiduciary financial advisor.
Frequently Asked Questions About Treasury Bonds
Treasury bonds pay interest every six months until they mature. For example, you could invest in a Treasury bond that pays interest on February 15 and August 15 each year. However, a different Treasury bond might pay interest every May 15 and November 15.
Any interest income you earn from Treasury bonds is subject to federal income tax. However, any earned interest income is generally exempt from state and local income tax.
You can sell a Treasury bond before it matures via the secondary market, a place where investors trade previously issued financial securities with each other. To sell on the secondary market, you must go through a bank, broker or dealer.
Rising inflation can cause interest rates to rise, which makes the value of a Treasury bond decrease. This happens because the purchasing power of the remaining coupon payments and principal is diminished. If inflation remains stable (and all other factors remain the same), the value of a Treasury bond will not change.
For the most part, as interest rates go up, you can expect Treasury bond prices to fall. Conversely, when interest rates go down, prices for Treasury bonds will rise. But not all Treasury bonds have the same price. Generally, the longer it takes for a Treasury bond to reach maturity, the more you’ll pay for it — and the more sensitive its price will be to changes in the interest rate.
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