Treasury bonds are government bonds with a term of twenty or thirty years and pay a fixed interest rate on a semi-annual basis. They earn interest until maturity, and the owner also receives a face value, or principal, when the government bond matures. This interest is exempt from state and local taxes, but is subject to federal income taxes, according to TreasuryDirect.
Treasury bonds are tradable securities, so they can be sold before maturity – unlike U.S. savings bonds, which are non-tradable securities and are issued and registered to a specific owner and cannot be sold on the secondary financial market.
What government bonds pay in interest
Let’s look at an example of how government bonds work and what they can get you.
Imagine that a 30-year U.S. Treasury bond pays a coupon rate of about 3 percent. That means the bond pays $30 per year for every $1,000 of face value (par value) you own. So the semi-annual coupon payments are half that, or $15 per $1,000.
Interest payments are made directly to your TreasuryDirect.gov account, if you use it to hold your securities. If you keep your bonds with a broker, that’s where the interest goes.
The yield on 30-year government bonds is approximately 4.25 percent as of April 2024.
When a government bond is issued, the coupon rate remains fixed for the life of the bond, but the price of the bond can change as it trades in the market. If the price of a bond rises, the yield falls, even though the coupon rate remains the same. Conversely, if the price of a bond falls, the yield will rise even though the coupon rate remains the same. Either way, when the bond matures, you will receive the face value of the bond back.
If the coupon rate is higher than the interest rate, it means the bond is selling at a premium, says Greg McBride, CFA, chief financial analyst at Bankrate.
With a stock, you know what its price is today, but you don’t know what its future value is. But with a bond, you know what its terminal value will be when it matures, McBride says.
“If the price is now above face value, your return will be less than the coupon rate because you may have paid $110 for the bond and it matures at $100,” says McBride. “Conversely, if you buy it for less than face value, your yield to maturity will be higher than the coupon rate. Because at maturity, the bond you paid $95 for will now earn you $100.”
How to buy government bonds
Investors have two main ways to buy government bonds:
- Purchase new bonds directly from the U.S. Treasury Department, a bank, or a broker
- Buy existing bonds from the bond exchange through a bank or broker
You can buy government bonds electronically at TreasuryDirect through non-competitive bidding. Non-competitive bidding means that you agree to the return set at the auction and are guaranteed to receive both the desired amount and the specific bond.
T-bonds can also be purchased through banks, brokers or dealers through a competitive or non-competitive bid. With a competitive offer, you specify the return you will accept and you may or may not get the bond you want. If you receive the government bond, it may be a smaller amount than what you applied for.
The government bond auctions take place four times a year: in February, May, August and November. You must purchase a minimum of $100 worth of government bonds and these are sold in $100 increments. The maximum amount of government bonds you can buy in one auction is $10 million for non-competitive bidding or 35 percent of the original bid amount for competitive bidding.
Because government bonds are traded on an exchange, you can of course also buy them anytime the market is open through a broker or bank that offers such services. Those bonds won’t be new, but that’s largely irrelevant.
Who should invest in government bonds?
Treasury bonds may be suitable for someone looking for safety because Treasury bonds are backed by the “full faith and credit” of the U.S. government. US government bonds are de facto the safe haven for investors, says McBride.
“So when the stock market falls, you will often see investors flocking to the safety of government bonds,” says McBride.
Investors are often looking for the safety that bonds offer and are less concerned about returns.
Government bonds can also be an option to diversify your portfolio, for example if you invest heavily in shares. They tend to reduce a portfolio’s volatility and typically fluctuate much less than stocks, which are known for their volatility. By diversifying your portfolio, you can smooth out your returns and reduce the overall risk in your portfolio.
But that doesn’t mean bonds are a good choice in all situations, especially when bond yields are very low. Then bonds can actually be risky.
Risks on government bonds
Although government bonds do not carry a serious risk that the government will not pay you back, they do carry two other risks that are typical of bonds: inflation risk and interest rate risk.
Although government bonds are relatively safe investments, a major risk is that inflation will erode your returns over the years. When you get back the face value of the bond, it will no longer have the same purchasing power as it did twenty or thirty years earlier.
A government bond with a term of 30 years yields approximately 4.25 percent (as of April 2024). If that return is not higher than inflation, your investment will lose purchasing power.
“Investors should expect inflation to average around 3 percent over the next 30 years,” says McBride.
McBride says that $1,000 will only have a purchasing power of $476 in three decades, if inflation averages 2.5 percent over that period. As of April 2024, the inflation rate will be approximately 3.5 percent.
“So this is not something that is going to increase your purchasing power or your wealth in any meaningful way,” McBride says. “And you run a huge interest rate risk if you have to sell before the maturity date for whatever reason.”
Interest rate risk is the risk that interest rates will move unfavorably. If interest rates rise, the price of your bond will fall. That may not be a problem if you don’t have to sell your bond before maturity. But if you want or need to sell it, you can’t sell it for face value, but perhaps much less. And the longer your term, the more the bond will be affected by changes in interest rates.
Rising interest rates have had an impact on bond prices in recent years, McBride says.
Do government bonds pay high interest?
A number of other government bonds (such as government bonds) are paying the highest yields in more than a decade. Interest rates on government bonds have also risen in recent years.
Investors are demanding higher returns because of the rise in inflation, McBride says.
Many people appreciate the safety offered by investing in Treasury bonds, which are backed by the U.S. government. But that safety comes at a price: a lower coupon rate. Investors looking for higher interest payments can turn to corporate bonds, which tend to yield more. But for that extra return, they will have to take some extra risk.
Buying a bond issued by one of the top companies may carry relatively low risk, but the risk is still not as low as buying a U.S. Treasury bond. And corporate bonds can range from relatively safe to extremely risky, so you need to know what you’re buying when you buy them.
Some inflation-linked government bonds have started paying higher interest rates to account for rising costs. Government-issued Series I bonds purchased between November 2023 and April 2024 will pay an annual interest rate of 5.27 percent, according to TreasuryDirect. The interest rate on I-bonds depends on inflation and changes every six months.
Another option is Treasury Inflation Protected Securities (TIPS), which are government bonds designed to preserve the investor’s purchasing power.
“The price of the bond is adjusted according to the change in the consumer price index,” says McBride.
For TIPS, as the price of the bond increases, the amount of the coupon also increases. Over the life of the bond, between upward adjustments in the bond’s price and the increasing dollar amount of the coupon, the investor’s purchasing power is preserved, McBride says.
Are government bonds a good investment?
Whether government bonds are a good investment depends on your own financial situation.
For people who are risk-averse and want the safety of bonds sold by the U.S. government, they could be a good choice. But for those saving for long-term investment goals such as retirement, government bonds are unlikely to provide sufficient returns to meet your goals or even beat inflation.
Those looking for a low-risk investment may also consider high-yield savings accounts or certificates of deposit offered by banks backed by the Federal Deposit Insurance Corp. (FDIC). Your money is protected from bank failure if it falls within FDIC limits and guidelines.
These accounts pay an annual yield (APY) that reflects the general interest rate level, but you can quickly access cash in a high-yield savings account, and you can top up CDs to potentially take advantage of a rise in interest rates. prices.
Those looking for higher long-term returns will likely need to turn to stocks or stock funds for at least part of their portfolio. These investments are regularly among the best long-term investments and allow you to beat inflation and grow your purchasing power over time.
Please note: Bank interest Rachel Christian also contributed to this story.
