- A Treasury bond is a type of debt security that’s distributed and backed by the US government.
- Investors can buy several types of Treasury securities depending on their investment horizon.
- Some Treasuries earn interest incrementally while others pay out at maturity.
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A Treasury bond is a government-backed debt security that’s issued by the US Treasury. Several types of securities – including bills, notes, bonds, and more – fall into this category. Depending on the type of bond you buy, maturities range from four weeks to 30 years, and interest might be paid regularly or at maturity.
“Treasury bonds are all fairly secure, but they don’t yield high results,” says Jim Pendergast, senior vice president of altLINE, a division of The Southern Bank Co. “The key is to find a Treasury bond that keeps your money safe while simultaneously keeping you current with inflation.”
Before buying a Treasury bond, it’s important to understand the different types, how they work, and some of their pros and cons.
Understanding how Treasury Bonds work
When you buy a Treasury security, you’re essentially lending money to the government, which promises to repay you at a certain date.
The wide range of maturities available allows you to choose the type of security that aligns with your investing goals. Once you purchase a Treasury security, you’ll need to hold it for at least 45 days but can redeem it anytime after that. Of course, investors receive the maximum return by waiting until the maturity date. Investors earn interest while they hold the security, either periodically (such as every six months) or upon redemption.
The interest you earn on Treasuries is subject to federal income taxes. Increases in principal value may be taxed, too. But you won’t pay state or local income taxes.
Some investors stash their emergency funds in Treasury securities because they’re safe and liquid. However, you may pay a penalty if you redeem before maturity. Plus, “you might get the same or a similar interest rate from a high-yield savings account that you can access at any time,” says John Mendes, a CPWA with Rise Wealth Strategies. Therefore, a savings account might be the way to go if you prioritize liquidity without extra steps involved.
What are the different types of Treasury Bonds?
While you might hear the term Treasury bond applied to any government security, there are actually several types. The main differences are when the securities mature and how interest is paid.
“Many argue that keeping up with inflation is the best strategy when choosing your treasury bonds,” Pendergast says. “However, occasionally your investment won’t correctly reflect inflation. Inflation rates are based on the CPI’s findings, which means that they measure averages.”
Here are the different types of Treasury bonds:
Treasury bills mature within four, eight, 13, 26, or 52 weeks. They’re sold at a discount, which means you can buy one for a price below its face value. But you receive the full face value (plus interest) at maturity. These are “notorious for having extremely low returns,” says Pendergast.
Treasury notes mature within two to 10 years and pay interest every six months. They’re sold at a discount, coupon, or premium, which means the price can be less than, equal to, or greater than the note’s face value.
Treasury bonds are also sold at discount, coupon, or premium and mature in 20 years or 30 years. Bondholders receive interest every six months.
Treasury Inflation-Protected Securities (TIPS) mature within five, 10, or 30 years and pay interest every six months. TIPS can help protect your investment against inflation because the principal increases with inflation. (Though it also decreases with deflation.) At maturity, you receive either the adjusted principal or original principal, whichever is greater.
Floating-rate notes (FRNs) mature in two years and pay interest quarterly. The interest payments increase or decrease based on discount rates for 13-week Treasury bills. These are sold at discount, coupon, or premium. “Most FRNs come with the risk of falling,” Pendergast says. “Sometimes interest rates plummet, making them an unstable choice for investment(s).”
Separate Trading of Registered Interest and Principal of Securities (STRIPS) are available only through private financial institutions.
Here’s how STRIPS work:
- The firm starts by taking an eligible Treasury note, bond, or TIPS, and separating the coupons (interest payments) from the principal.
- They then sell the pieces to investors at steep discount prices.
- Investors can then redeem the security for full face value at maturity.
|Treasury type||Minimum denomination||Sold at||Maturity||Interest payments|
|Treasury bills||$US100 ($AU133)||Discount||4, 8, 13, 26, and 52 weeks||Interest and principal paid at maturity|
|Treasury notes||$US100 ($AU133)||Discount, coupon, or premium||2, 3, 5, 7, and 10 years||Every six months|
|Treasury bonds||$US100 ($AU133)||Discount, coupon, or premium||20 and 30 years||Interest paid every six months, principal at 20 or 30 years|
|Treasury Inflation-Protected Securities (TIPS)||$US100 ($AU133)||Coupon||5, 10, and 30 years||Interest paid every six months, principal paid at maturity|
|Floating rate notes (FRNs)||$US100 ($AU133)||Discount, coupon, or premium||2 years||Interest paid quarterly, principal at maturity|
|Separate Trading of Registered Interest and Principal of Securities (STRIPS)||$US100 ($AU133)||Discount||Varies||Interest and principal paid at maturity|
Pros and Cons of Treasury Bonds
Treasury bonds come with some benefits and drawbacks, so consider these points before investing:
- Credit quality: Treasury securities are backed by the US government, so they’re generally considered to be the highest credit quality.
- Tax advantages: The interest you earn is subject to federal income taxes but not state or local income taxes. However, you may have to pay taxes on principal gains.
- Liquidity: Investors can buy and sell Treasury securities both at regularly scheduled auctions and in the secondary market. The exact price depends on their coupon rate, compared with prevailing interest rates.
- Choice: Depending on their needs, investors can buy Treasury securities in various structures with maturities that range from four weeks to 30 years.
- Lower yield: You’ll typically earn less interest on Treasuries compared with other, riskier securities.
- Tax considerations: If you buy a bond at discount and either hold it until maturity or sell it at a profit, that principal gain will be subject to federal and state taxes.
- Interest rate risks: As are all bonds, Treasury bonds are subject to price volatility as a result of changes in market interest rates.
- Inflation risk: The interest earned on Treasury securities may not keep pace with inflation (with the exception of Treasury inflation-protected securities, or TIPS).
- Credit or default risk: All bonds also have a risk of default, so Treasury holders should monitor their investments for signs of increasing default risk.
The major drawback to Treasury securities is their low yield.
“Interest rate risk is real,” says Alexander Campbell, a registered investment adviser and accredited investment fiduciary with A.G. Campbell Advisory LLC. But it’s wise to remember that “fixed income is an important asset class in managing our investment portfolios,” Campbell says. “It is often the fixed-income component that keeps us able to invest our other monies for the long term in stocks.”
How to buy Treasury Bonds
Treasury securities are available either through the US Treasury or from a private financial-services firm.
Buy from the US Treasury
You can buy newly issued Treasury securities straight from the source at TreasuryDirect.gov. After setting up an account, you’ll place a bid at one of the regularly held auctions. T-bill auctions are held weekly, T-note auctions are held monthly, and T-bond auctions are held four times a year (on the first Wednesday of February, May, August, and November). The minimum buy-in amount is $US100 ($AU133) for each type of security.
At the auction, there are two ways to place a bid:
- Non-competitive bidding: When you make a bid, you agree to accept whatever interest rate is decided at the auction. In exchange, you’re guaranteed to have your bid accepted and you’ll be paid face value upon maturity.
- Competitive bidding: You can also specify the interest rate you want to receive for the Treasury, but your bid will only be accepted if it is less than or equal to the rate set by the auction.
Buy through a bank or broker
You can also buy Treasury securities through a financial institution, such as a bank or brokerage. Each institution sets its own minimum buy-in, so you might need to invest more than you would at TreasuryDirect. You have two main options when purchasing a security through a private firm:
- The firm buys on the government site. The financial institution will monitor the TreasuryDirect auctions and place a bid for you on a newly issued security. This process is simple, but you may pay a fee for the convenience.
- The firm buys on the secondary market. The financial services company will purchase an existing Treasury security for you on the secondary market. You might also have the option of buying a Treasury bond mutual fund or exchange-traded fund (ETF) through the brokerage. But with all of these options, commission fees may apply.
The financial takeaway
Treasury securities are super-low-risk investments that come with varying maturity timelines and interest payments. They’re also liquid because investors can sell them at any time for cash as long as the markets are open. But because these investments typically earn less compared to stocks and some other assets, investors should consider diversifying to limit risk and grow money at the same time.