Guidebook icon with text, Treasury Bonds

Investing is all about finding a balance between risk and reward. Want to invest in a hot-shot new tech startup? You could make it big — but you could also lose significantly, and that level of risk may not suit your needs and goals. Prefer to keep your capital secure with relatively little risk (in exchange for less opportunity for growth)? You might want to consider treasury bonds.

What are Treasury bonds?

Treasury bonds — also known as Treasurys or T-Bonds — is the umbrella term for different types of bonds issued by the U.S. Treasury. These fixed-income securities are backed by the full faith and credit of the United States government, which makes them about as low-risk a security as you can invest in.

Treasury bonds typically carry less risk than other types of bonds, like municipal bonds and corporate bonds. In exchange for that safety, you’ll have to be willing to accept a correspondingly modest return when adding Treasurys to your portfolio.

Types of Treasury Bonds

When you invest in bonds, you essentially loan money to the bond issuer under the assumption that you’ll be paid back in full (plus interest) at the bond’s maturity date.

Treasury bonds work the same way, and the length of time until maturity is how these bonds are categorized. The three main types of Treasurys based on the time frame of the loan are:

  • T-Bills: the shortest-term variety that matures in one year or less
  • T-Notes: mid-range loans with maturities of two, three, five, and 10 years
  • T-Bonds: the longest-term loans, which mature in 30 years.

T-Bills operate a bit differently than other treasury bonds, since these loans can be for a term as short as just four weeks or as long as 52. Their face value is $1,000 per bill, but they’re issued in the primary market at a discount. An investor then receives $1,000 when the bill matures — and your profit is the difference between what you paid and the bond’s face value (a.k.a. $1,000).

The two longer-term Treasurys — T-Notes and T-Bonds — pay interest every six months, or twice per year until the bond matures. Because T-Bonds are the longest loans, they typically offer the highest interest rates.

A special form of T-Bonds and T-Notes are called Treasury Inflation-Protected Securities, or TIPS for short. TIPS are market securities whose principal is tied to changes in the Consumer Price Index (CPI), an index that measures inflation. TIPS’ principal increases with inflation (rises in the CPI) and decreases with deflation (declines in the CPI). TIPS pay a fixed rate of interest twice annually, and that interest rate can fluctuate with current inflation levels.

TIPS can help protect the purchasing power of your money, as inflation can cause money to lose value over time. For example, $1,000 today could be worth more than the value of $1,000 in 20 years, if inflation occurs. So, to protect against your investment losing value if inflation does kick in, your TIPS principal would increase accordingly. Then, you’d be paid a fixed rate of interest based on your inflation-adjusted principal.

You can buy TIPS in five-, 10- or 20-year maturities in increments of $100 each. Upon maturity, you get either the inflation-adjusted principal or the original principal.

How to Buy Treasury Bonds

Buying treasury bonds can be a way to balance out higher-risk investments in your portfolio. As your risk tolerance changes, you may consider buying more over time. But how exactly can you invest in Treasurys? You have three options.

Noncompetitive Bid Auction

One way to purchase Treasurys is through a noncompetitive bid auction. This is typically the most popular method for individual investors. In this type of auction, it’s guaranteed you can buy the bond you want, but you must be willing to accept the interest rate set at the auction.

To place a noncompetitive bid, you can go directly to TreasuryDirect.gov (the U.S. Treasury’s portal), or you can invest through a bank or broker, like Ally Invest. The maximum amount you can buy in a single auction is $5 million in bonds.

Competitive Bid Auction

Another method for buying Treasurys is through a competitive bid auction. Here, you specify the yield, or interest rate, you are willing to accept. Your bid will be accepted based on how it compares to the set interest rate of the bond. If your bid is equal to or below the rate set at auction, you will receive the security. Your bid may be rejected if the yield you specify is above the set rate.

The competitive bid method is typically used by institutional investors or investors that are experienced in the securities market. You can place competitive bids through a bank or broker. The maximum purchase you can make in a competitive bid is 35% of the Treasury’s offering.

Secondary Market

Finally, you can buy Treasurys through the secondary market. This is where treasury bonds are bought and sold before the securities reach maturity. This market is facilitated by banks and brokers. Treasurys that trade on the secondary market are more liquid and may see more price fluctuation based on current auction and yield rates.

Benefits of Buying Treasury Bonds

Depending on the level of risk you are willing to take on in your portfolio, your asset allocation may lean more heavily toward stocks or bonds. As your risk tolerance decreases, you might rebalance your portfolio and invest increasingly in bonds in order to keep your capital more secure. If you prefer a more conservative investment strategy, that’s where treasury bonds can be beneficial, as they are a relatively low-risk loan.

The Treasury has never defaulted on a federal loan, and its debt securities are basically considered as safe as cash. (However, the Treasury’s credit-worthiness won’t prevent losses if you’re selling your bonds before maturity on the secondary market.) In fact, Treasurys are considered such a low-risk investment, they’re often used as the prime benchmark of safety when it comes to securities.

Drawbacks of Buying Treasury Bonds

Ultimate safety comes with tradeoffs. Treasurys pay the lowest rate of interest of all bond types in exchange for being an extremely sure thing. So, while you can feel confident your money is safer than it would be in the stock market, the opportunity for gains is significantly lower.

If you buy TIPS, you have another risk to consider in the event deflation occurs. Like other Treasury bonds, TIPS carry a low risk of default. But deflation, or a drop in the CPI, means your principal would correspondingly adjust downward, so your interest payments would be less than if the CPI had stayed flat or showed evidence of inflation.

If deflation occurs, TIPS products could expose you to significant capital losses. But rest assured: At maturity, a useful safeguard kicks in. If the adjusted principal is less than the security’s original principal, you’d be paid the original principal. But if you sell your TIPS before they mature, no such safeguard exists.

What to Consider Before Buying Treasurys

Time Horizon

As you approach the time horizon for your financial goals, you might gradually shift from higher-risk investments like stocks or other bonds to Treasurys. But these bonds can be utilized across all time frames, from the extreme short-term to the extreme long-term. Your time horizon may vary according to your investment objectives, asset allocation, risk tolerance, and available capital. Try to choose a bond with a maturity date that coincides with when you expect to need your money.

Management

Usually, investors purchase Treasurys with the intention of holding them to maturity, which makes for a low-maintenance investment. But the interest payments you receive while holding T-Notes or T-Bonds will need some attention. Each individual coupon payment may not seem like much money, but stashing these payments in a savings account, like an Ally Bank Online Savings Account, can be a smart way to supplement your savings. You might also consider reinvesting these funds to purchase additional bonds on an annual basis.

Tax Ramifications

The interest earned on investments in Treasurys are taxable at the federal level but exempt from state and local taxes. Consult your tax adviser for more details.

Volatility Factor

Fluctuation in bond prices is a factor of changes in interest rates and changes in credit quality. If you hold your bonds until maturity, the volatility they experience between now and then doesn’t change the fact that you will receive the full face value when you sell. In general, prices of Treasury securities tend to fluctuate the least when compared to other bonds due to their very high credit-worthiness (and therefore, their low risk). Increased time-to-maturity, higher coupons, longer duration, and bonds trading at a discount are all additional factors which can increase the volatility of bond prices.

Buying Treasurys can be an opportunity to add balance to your portfolio and mitigate some of the risk you incur with more volatile securities. These secure loans are backed by the U.S. government and have an extremely low chance of defaulting — so you can rest assured that the money you’ve invested is in good hands.

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