What is a U.S. Treasury Bond?
What is a U.S. Treasury Bond?
Uncovering the Process of Purchasing Treasury Bonds
A U.S. Treasury Bond, often referred to as a "T-Bond," is a loan that the U.S. government takes out to gather funds. When you buy a T-Bond, you're essentially lending money to the federal government, and they pay you a predefined interest rate up until the loan's repayment date.
The U.S. government fully guarantees these securities, meaning the chance of not getting your money back is virtually nonexistent.
A bond is essentially a loan you give to a specific entity, such as a corporation, a local government, or in this case, the U.S. government. You loan an initial amount, called the principal, and receive interest payments until the loan's repayment or maturity date. At maturity, you should be returned the entire principal, along with the final interest payment.
Bonds
Bonds refer to debt securities that provide the holder with interest payments. Technically, all the securities mentioned below are bonds, but the U.S. government uses the term "Treasury Bond" specifically for its long-term, fundamental security. Treasury Bonds are issued in terms of 20 and 30 years and pay interest every six months.
However, you do not need to hold the bond for the full term. You can sell it at any time, but you must hold bonds purchased directly from the Treasury within your account for 45 days.
Related terms such as "note" and "bill" are used to describe shorter-term bonds. Treasury Bills have a lifespan of four weeks to one year, while Treasury Note maturity dates range from two years to ten years.
U.S. Treasury securities of various lengths serve as a relatively safe source of income and maintain their value in most economic situations. This makes them highly attractive to both large and small investors during periods of economic uncertainty.
Despite low risk, investing in Treasury securities typically results in lower interest rate returns than corporate bonds, depending on your investment goals and age. Regardless, a small percentage of your investment portfolio in bonds, specifically Treasury securities, is advised.
Interest Rate Risk
Whether you've learned this through formal studies or not, it's essential to know that as interest rates rise, the value of existing bond holdings decreases.
Imagine buying a three-year note with a 3% interest rate. A year later, interest rates increase. Now, you can buy a two-year Treasury note paying 4%. Would anyone want to buy your 3% note (with two years remaining) at face value when they can purchase a new two-year Treasury note offering a higher yield? To sell your note, you'd have to accept a lower price than your initial investment for it to be more attractive than the newly issued Treasury notes.
This concept represents interest rate risk, which deals with the risk of loss due to changes in interest rates. Long-term bond values are particularly sensitive to changes in interest rates.
Like all long-term bonds, Treasury bonds carry a substantially high risk that interest rates will rise during a 30-year period. As interest rates increase, your bond's value decreases accordingly. To compensate for interest rate risk, long-term issues generally offer a higher rate of interest than shorter-term issues.
While you'll still receive the full face value when the Treasury bond matures, interest rate risk applies only if you intend to sell your holdings before maturity.
Interest Rate
An interest rate is the cost of borrowing money or the premium you get for lending money. Learn about how interest rates impact the economy.
How to Invest in Treasury Bonds
How to invest in Treasury Bonds
There are two primary methods to acquire individual Treasury securities: through TreasuryDirect, the official U.S. Department of the Treasury website for managing Treasury bonds, or via your online broker.
Many brokers enable buying and selling Treasury securities directly within your brokerage account. However, brokers often require a minimum purchase of $1,000 for Treasury securities. You can purchase most securities in $100 increments on the TreasuryDirect website.
Keep in mind that the interest earned on Treasury securities is exempt from state and local taxes, but it is subject to federal income tax.
Types of Treasury Bonds
Treasury Notes
Treasury Notes are the intermediate-term Treasury security and are currently offered in terms of two, three, five, seven, and 10 years. Intermediate-term bonds give a good balance between the relatively high risk of long-term bonds and the low returns of short-term bonds, making them an excellent starting point for investing in Treasury securities. Interest rates vary based on the bond term, with longer-term notes usually offering higher interest rates.
Treasury Bills
Treasury Bills, or T-Bills, are the short-term version of Treasury securities and are offered in terms of four, eight, 13, 17, 26, or 52 weeks. A special variation of the T-Bill, known as the "cash management bill," is typically issued in terms of just a few days.
Unlike Treasury notes and bonds, Treasury bills don't provide interest payments during their term. Instead, T-bills are sold at a discount. For instance, if a T-bill is issued at a 1% interest rate, a buyer would purchase a $1,000 T-bill for $990.10. Upon maturity in a year, the Treasury Department pays back the investor $1,000; this includes the initial $990.10 paid for the bond and an additional $9.90 in interest.
Treasury bills generally offer the lowest interest rates among all Treasury securities. Surprisingly, short-term bills may sometimes provide higher returns than longer-term notes or bonds. This phenomenon is called a yield curve inversion. On a graph of yields vs. term length, yields typically ascend as the term extends. Conversely, when a shorter-term security yields more than a longer-term one, the curve inverts, sloping downward. A yield-curve inversion often signifies economic instability or a potential recession.
Yield Curve
The yield curve illustrates the relationship between interest rates and bonds. It reveals how this relationship is utilized to forecast the economy's trajectory.
Savings Bonds
Unlike other kinds of Treasury securities, savings bonds can only be obtained directly from the U.S. government. They serve as a means of saving money rather than an investment tool. Savings bonds are issued in two varieties: Series EE and Series I. The interest accrued on Series EE bonds is typically low, around 2.6% as of now. Series EE bonds, however, guarantee a 20-year doubling of the bond's value, equating to a 3.5% annual return if kept for exactly 20 years.
A Series I bond is an inflation-adjusted savings bond that pays a fixed rate of interest in conjunction with a semiannual rate that varies based on inflation. This results in regular rate adjustments. Although the fixed rate is often minimal, the inflation adjustment may make it rewarding. During periods of substantial inflation, like 2021, Series I bonds became alluring to the average investor.
Savings bonds can be redeemed after one year, but if they are redeemed before five years have transpired, the investor loses the last three months' worth of interest. Savings bonds mature after 30 years and cease paying interest at that point.
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Choosing Treasury securities
For most investors, Treasury marketable securities are typically more appealing than savings bonds.
You may want to consider Treasury notes as the foundation of your bond investment strategy. Treasury notes with a 10-year maturity date are an excellent pick for bond ladders, which are portfolios containing bonds with differing maturity dates.
You can defer taxes on interest payments by investing in Treasuries within a tax-deferred retirement account. However, if other income-generating assets consume your retirement funds, you might choose to hold Treasuries in a taxable account since they don't incur state and local income taxes.
As you approach retirement, consider increasing your bond allocation vs. stock allocation. Once retired, you can enjoy the safe and steady income from your bond portfolio of Treasuries.
Frequently asked questions about Treasury bonds
Are Treasury bonds a good investment?
Many investors can benefit from incorporating Treasury bonds into their portfolio. Treasuries have historically served as an effective diversifier for stocks. Treasury's asset class value is negatively correlated with stock value, indicating that Treasury bond value often increases when stock prices decline, providing stability for the portfolio. However, Treasury's expected return is significantly lower than that of stocks. Investors seeking maximum long-term returns without regard for portfolio volatility may not find Treasury bonds appealing.
How much do one-year Treasury bonds pay?
The yield on one-year Treasury bonds varies at each new auction organized by the U.S. Treasury. In typical market conditions, investors can expect one-year yields to be more than six-month yields and less than two-year yields. However, the yield curve may invert during unusual market conditions, causing one-year yields to be lower than two-year yields. As of late December 2024, one-year Treasury bonds yielded approximately 4.20%.
What are the three types of Treasury bonds?
Treasury bonds are categorized based on their term until maturity. Bonds that mature within one year of issuance are referred to as Treasury bills. Treasury notes mature between two to 10 years. And Treasury bonds are long-term securities with maturity periods exceeding 20 or 30 years.
How do I buy Treasury bonds?
You can buy Treasury bonds directly from the U.S. Treasury through TreasuryDirect. Alternatively, you can buy Treasuries on the open market through your investment broker. Most brokers offer a search tool to help investors find bonds that suit their investment plans. Additionally, using a broker is the simplest way to hold Treasury bonds within your retirement account.
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When purchasing a T-Bond, you're essentially lending money to the federal government and in return, they pay you a predefined interest rate. This is an example of investing in finance.
Investing in Treasury securities, such as notes or bonds, can serve as a relatively safe source of income and maintain their value in most economic situations. This makes them attractive to both large and small investors during periods of economic uncertainty.
