Everyone wants to hop on the stock bandwagon while the market is rallying, but no matter how hot stocks are, every portfolio should include some low- or no-risk investments. Treasury bonds are a good way to earn interest and take some risk off the table — and they’re easy to buy. Like every investment, bonds have advantages and disadvantages, so take a closer look and decide if bonds work for your financial plan.
What Is a Treasury Bond?
A Treasury bond, sometimes called a T-bond, is a security that is sold by the U.S. government when it needs to raise money. When you buy government bonds, you are loaning money to the government, which agrees to pay you back with interest. You get interest payments twice a year and your original investment back at the end of the bond’s term.
For example, suppose you have $10,000 to invest. You want to earn interest but don’t want to take any risk and you can leave the money invested for a long time. You decide to purchase 30-year Treasury bonds. The coupon, or interest, rate on a 30-year Treasury bond is 2.75 percent as of Oct. 5, 2017.
That means that you’ll get $275 per year in interest — in two payments of $137.50 — for the next 30 years. At the end of 30 years, you’ll get your $10,000 back. Although a 30-year bond is the most common type of bond, you can buy one with a shorter maturity, like a 10-year bond.
Keep in mind that bond rates can vary. A bond that has a $10,000 face value might sell for less if the interest rate is higher than the bond’s coupon rate.
Savings Bonds vs. Treasury Bonds
It’s worth noting that Treasury bonds are different from U.S. savings bonds. You purchase savings bonds for half their face value and redeem them for face value when they mature. Treasury bonds are also different from Treasury bills, which have much shorter maturities.
What Makes a Treasury Bond a Good Investment?
Treasury bonds are backed by the full faith and credit of the U.S. government, which means there is very little risk you won’t get your money back. Bonds also pay interest while you own them, so every six months you get a check — or you can reinvest the interest.
The interest is subject to federal income tax, but you won’t pay taxes at the state or local level. If you live in a state with a high state income tax, like New York or California, this can be a big advantage.
When you purchase Treasury bonds, you get a guaranteed rate of interest. Treasury bond rates remain the same over the 30-year term of the bond.
Keep Reading: Stocks and Bonds — How to Choose the Best Investments
How to Buy Bonds
Buying bonds isn’t difficult, but you need to understand the process so you can do it correctly. Bonds are sold at auction, so you place bids on the ones you want. The price in the bond market will change to reflect the prevailing interest rate.
For example, you might pay $9,717 instead of $10,000 for your 30-year bond, which would give you a yield of 2.89 percent instead of the stated coupon yield of 2.75 percent. You’ll still get 2.75 percent interest and your $10,000 when the bond matures, but you will have paid less for the bond. When interest rates rise, bond prices drop — and vice versa — so when you buy matters.
You can purchase bonds directly from the government — at TreasuryDirect.gov — or through a broker, dealer or bank. If you purchase directly from the government, you must place bids for the bonds you want — these are noncompetitive bids because you know and agree to the price you will be paying. The minimum purchase price is $100 and you can specify how many you want to buy in increments of $100.
Find Out: Who Can Legally Issue Bonds
It’s a straightforward process to purchase Treasure bonds online from the government. Here’s how:
- Visit TreasuryDirect.gov.
- Under the large, green “Individuals” tab, click on “Treasury Securities and Programs.”
- Click on “Treasury Bonds,” then “Buy bonds in TreasuryDirect.”
- Open an account with your Social Security number, email address and banking information.
- Choose an auction date. Original-issue Treasury bonds are auctioned in February, May, August and November. Reopened bonds — additional amounts of a previously issued security — are auctioned in the other months.
- Submit a bid — indicate how much you want to invest because the price is set. You can invest a maximum of $5 million per auction.
- When the auction closes, you will be awarded your bonds electronically.
When you purchase through a broker, dealer or bank, you can submit a noncompetitive bid like you would from the Treasury. You can also submit a competitive bid and specify the yield you want. The price you bid might or might not be available and you might not get a number of bonds you want.
Pros and Cons of Treasury Bonds
Treasury bonds are popular because they are safe investments. The interest you earn is not taxed at the state or local level and you’ll get a guaranteed rate of return, plus two interest payments per year.
Buying Treasury bonds does have some disadvantages, though. The rate of return, although typically higher than a bank or credit union savings account, is modest. The U.S. government does not issue high-yield bonds. Treasury bonds take 30 years to mature — you can redeem them before their maturity, but you might have to sell at a discount.
The biggest disadvantage of buying a Treasury bond is that the interest rate could rise during its term, which means your money might be tied up in an investment that pays 2.75 percent interest when you could be getting 4 percent or 5 percent — or more. If you try to redeem your bond to take advantage of rising rates you won’t get as much for it.