A Treasury bond is debt issued by the U.S. government to raise money. Technically speaking, every kind of debt issued by the federal government is a bond, but the U.S. Treasury defines the Treasury bond as the 30-year note. Related terms "note" and "bill" are reserved to describe bonds that range in maturity length between four weeks and 10 years. Generally considered the safest investment in the world, U.S. Treasury securities of all lengths provide a nearly guaranteed source of income and hold their value in just about every economic environment. This makes them incredibly attractive during periods of economic uncertainty for investors large and small.
No matter your age or investing goals, it's a good idea to have at least a small percentage of your portfolio in bonds. And Treasury securities -- the bonds issued by the US federal government -- are the safest of high-quality bonds and make a great linchpin of your bond portfolio.
All versions of Treasury securities share certain traits. They're backed by the full faith of the U.S. government, so their default risk is widely considered nonexistent. Because there's so little risk involved in these securities, their payment rates are typically low compared to those of corporate bonds or municipal bonds.
Technically, all the securities discussed here are bonds, but the federal government uses the term "Treasury bonds" to refer specifically to its long-term basic security. Treasury bonds are always issued in 30-year terms and pay interest every six months. However, you don't have to hold the bond for the full 30 years; you can sell it anytime after the first 45 days. Like all long-term bonds, Treasury bonds carry a significant risk that the interest rates will rise during that 30-year period, reducing the value of your bond. As a result, long-term issues often pay a higher rate of interest to compensate the bond purchaser for that risk.
How to invest in Treasury bonds
In general, there are two common ways to buy individual Treasury securities. You can buy them from Treasury Direct, the official Treasury Department website for managing Treasury bonds, or from your online broker. Many brokers allow you to buy and sell Treasury securities within your brokerage account; however, brokers often require a minimum purchase of $1,000 for Treasury securities, whereas on the Treasury Direct website, you can buy most securities in $100 increments. The interest paid on Treasury securities is exempt from state and local taxes, but is subject to federal tax.
Treasury notes are the intermediate-term Treasury security and are currently issued in terms of two, three, five, seven, and 10 years. Intermediate-term bonds are a good compromise between the relatively high risk of long-term bonds and the low payouts of short-term bonds, so they are an excellent place to start investing in Treasury securities. Interest rates vary depending on the bond term, with longer-term notes usually paying higher interest rates.
Treasury bills, or T-bills, are the short-term version of Treasury securities and are offered in terms of 4, 13, 26, or 52 weeks. A special version of the T-bill called the "cash management bill" is typically issued in terms of just a few days. Unlike Treasury notes and bonds, Treasury bills don't make interest payments; instead, T-bills are sold at a discount. For example, if a T-bill is issued at 1% interest, then an investor would buy a $1000 T-bill for $990. When the bill matures, the Treasury Department would pay the investor $1000: the $990 they forked over to buy it, plus $10 in interest.
Not surprisingly, Treasury bills usually pay the lowest relative rates of all the various Treasury securities; as of this writing, rates offered at recent auctions ranged from 0.13% for four-week issues to 0.16% for a one-year T-bill, while the 30-year Treasury bond pays 1.49%. Given that it's possible to find online bank savings accounts that pay more, T-bills are not a great buy if you are looking to save a cash amount that's within the FDIC insurance levels for bank deposits.
Unlike the other types of Treasury securities, savings bonds can be bought only directly through the U.S. government. They are designed as a tool for saving money rather than an investment option. They are issued in two types, Series EE and Series I. The interest paid on these bonds is typically very low, with EE bonds currently paying around 0.1%, but rates are updated often. An I bond is an inflation-protected savings bond that pays a combination of a fixed rate of interest (currently 0%) and a semiannual inflation rate (often around half a percent) that rises and falls with inflation -- leading to regular rate updates.
You can redeem either type of bond after one year, but if you redeem it before five years have passed, you lose the last three months' worth of interest. Savings bonds mature at 30 years and stop paying interest at that point.
Choosing Treasury securities
For most investors, Treasury marketable securities make a lot more sense than savings bonds. Consider making Treasury notes the backbone of your bond investing strategy; 10-year Treasury notes are a great option for bond ladders. Treasury securities are best kept inside a tax-deferred retirement account, since that will keep you from being taxed on the interest payments. Finally, as you get closer to retirement, increase your percentage of bonds compared to stocks. Once you retire, you'll be able to enjoy the safe and steady flow of income from your portfolio of Treasuries.