Our writers and editors used an internal natural language generation platform to assist with parts of this article, allowing them to focus on adding information that’s particularly useful. The article was reviewed, fact-checked and edited by our editorial staff before publication.
Diversification is an important strategy when it comes to investing, and one of the most common ways to diversify a portfolio is through bonds. As a form of government-issued debt, government bonds can be a useful addition to a balanced investment portfolio, especially as you near retirement, offering stability, regular income and tax benefits.
“U.S. Treasuries have provided safe havens, diversification and reliable income to generations of investors for most of their 90-year history,” said Craig Bolanos, Jr., a founding partner and CEO of Wealth Management Group, LLC, in Inverness, Illinois.
Here’s what you need to know.
What is a government bond?
Treasury bonds, often called T-bonds, are long-term loans to the U.S. government. When you buy a government bond, you are essentially lending money to the federal government. In return, the government agrees to pay you a fixed interest rate every six months for the life of the bond.
When the bond matures – in twenty or thirty years – the government pays back the original amount of the loan, also called the face value of the bond.
These bonds are issued by the Ministry of Finance, hence the name, and investors can purchase the securities directly from TreasuryDirect.com. You can also buy government bonds through a bank or broker, but you may pay a fee or commission for this. However, some of the best online real estate agents no longer charge fees or commissions on government bonds. For example, Charles Schwab and ETrade do not charge fees for new issues or secondary transactions on T-bonds.
Treasury bonds are generally considered a risk-free investment because the U.S. government has never defaulted on its debts. However, investors should understand that even U.S. Treasury bonds carry interest rate risk. That is, if market interest rates rise, the prices of these bonds will fall, as they did in 2023.
Types of government bonds
The U.S. Treasury Department offers several types of securities. Each has unique features and maturity periods that determine their interest rates and the way they are traded.
- T-bonds: These have an original term of 20 or 30 years and usually offer the highest interest rates for investors. Interest payments are made twice a year.
- T notes: The initial maturities for these securities range from two to ten years and typically come with lower interest payments than T-bonds. T-note payments are also made twice a year.
- T-accounts: These securities have the shortest duration, with maturities ranging from four weeks to one year. T-bills are sold at a discount to the bond’s face value, so investors earn the difference at maturity.
How do government bonds work?
Government bonds have a term of 20 to 30 years. A 30-year Treasury note has a minimum face value of $1,000, although they can be purchased in $100 increments if purchased directly from the U.S. Treasury.
The term ‘fixed income’ means that government bonds provide a fixed interest payout, paid to investors twice a year or every six months.
In addition to the semi-annual interest payments, bondholders ultimately receive the full principal amount of their investment back. When a government bond matures – meaning it has reached its maturity date and is expiring – the investor is paid out the full face value of the bond. So if the bondholder holds a government bond worth $10,000, he or she will receive the principal amount of $10,000 back and earn interest on the investment.
Government bonds are liquid, meaning they can be sold by bondholders before they mature. Treasury bonds can be traded on a secondary market, also known as the fixed income market, or more commonly, the bond market.
Of course, bondholders can also choose to hold the government bonds until the maturity date.
Interest on government bonds explained
The interest on government bonds (also called yield) is linked to the maturity date of the specific bond.
The T-bond yield represents the yield generated by the bond, and is the interest rate the U.S. government pays to investors to borrow their money for a specified period of time. For example, an investor who buys a $10,000 T-bond and earns 4 percent interest from Uncle Sam will earn an annual return of $400 from the purchase of government bonds.
So-called long-term Treasury bonds, including the 30-year T-bond, typically offer the highest interest payments of any security in the fixed-income family of U.S. Treasury bonds.
“Typically, the longer the due date, the higher the interest rate,” says Jacob Dayan, a partner at Consumer Law Group in Chicago.
The reason: Longer-dated bonds are riskier because a spike in inflation could reduce the value of interest payments.
Furthermore, if market-driven yields rise, causing the bond’s price to fall, the lower interest bond you own becomes a less attractive investment. (There are times, however, when shorter-term securities, such as a three-month T-bill, can yield more than a ten-year note. This phenomenon, known as an inverted yield curve, occurred in 2023.)
As of March 2024, the yield on 30-year U.S. Treasury bonds was approximately 4.37 percent.
Tax Implications for T-Bonds
From a fiscal perspective, government bonds are fairly simple.
Any interest earned on an investment in government bonds is exempt from tax at the state and local level, but that interest is taxed by the federal government.
If you hold Treasury bonds with the U.S. government, you can easily view the amount of interest you’ve earned on your IRS tax form 1099. If this is with your bank or broker, your financial institution can provide the taxable interest you earned on your T bond investment has earned. .
How government bonds fit into your portfolio
You’re not likely to get rich just by investing in T-bonds. The return is usually around 2 to 5 percent, and you should put your money away for a long time.
However, investors can use T-bonds to preserve the wealth they have already created.
“There is consistent income potential with government bonds, and your investment is unlikely to decline if the stock market plummets, as other investment vehicles can do,” says Chase Lawson, author of “Financial Freedom: Breaking the Chains to Independence and Creating Massive Wealth.” ”
Because T-bonds are among the safest investments available, they can also help limit risk within your portfolio during economic downturns.
“For many investors, U.S. Treasury bonds are the best choice for a flight to safety (transactions), as is most evident during periods of extreme market volatility,” says Bolanos.
The difference between government bonds and government bonds
Treasury bonds are part of a larger family of federal government bonds, consisting of Treasury bonds, Treasury bills, and Treasury bills.
“Treasuries and government bonds are essentially the same type of instrument, differing only in their original maturity,” explains Robert Johnson, professor of finance at Creighton University’s Heider College of Business.
The government issues government bonds with a term of 20 to 30 years and issues government bonds with terms ranging from two to ten years. Both buyers of government bonds and notes receive an interest payment every six months.
Treasury bills (T-bills), the government’s short-term debt, are different from both Treasury bonds and Treasury bills.
“T-bills are issued with original maturities of four, eight, 13, 26 and 52 weeks,” says Johnson. “They pay no interest and are issued on a discount basis (meaning your initial cost is less than the face value of the T-note). With T-bills, the investor receives a higher amount when the bill matures than he paid to acquire it.
Tips for investing in government bonds
Here are a few easy ways to buy government bonds:
- Buy directly. Whenever possible, it is preferable to purchase Treasury bonds directly from TreasuryDirect.gov. That way, you purchase your bonds from the federal government and eliminate the costs associated with purchasing bonds through an intermediary, as you would with a brokerage firm.
- Buy closer to your retirement. Wealth is more about capital growth during your savings and investment years and capital preservation during your later years – and for good reason. When you are young, investing in higher-risk, higher-reward stocks generates capital growth. In short, you create long-term wealth with your stock investments. However, when you are nearing retirement or have already retired, you will want to preserve the wealth you have created. You can achieve that through capital preservation instruments such as T-bonds, which represent lower-risk investments that reduce the chance of losing money in a market downturn.
- Go the ETF route. An effective, low-cost way to get into the government bond game is to invest in government bonds (ETFs) or exchange-traded funds. Any low-cost, diversified government bond-focused ETF that emphasizes a long-term component of T-bonds is worth a look. You can even mix and match different Treasury security funds. If you’re looking for inspiration, check out Bankrate’s list of the best bond funds for retirement investing.
If you’re looking for ETFs that invest in long-term government bonds, check out iShares 20+ Year Treasury Bond ETF (TLT) and Vanguard Long-Term Treasury ETF (VGLT).
In short
Government bonds can be an effective way to diversify your portfolio or preserve capital. They offer a fixed interest rate and are backed by the US government, making them a low-risk investment. While they may not provide the highest returns compared to riskier investments, they can provide stability to your portfolio, especially during times of market volatility. However, it is essential to take your financial goals into account. T-bonds can be an effective way to protect your wealth, but they aren’t necessarily a great way to build wealth.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making any investment decision. In addition, investors are advised that the past performance of investment products does not guarantee future price increases.
