Treasury bonds — also known as Treasurys or T-Bonds is the umbrella term for different types of bonds issued by the U.S. Treasury. Treasurys come in three main types based on the time frame of the loan:

  • T-Bills — the shortest-term variety maturing 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 maturing in 30 years.

Treasurys are widely regarded as virtually risk-free investments — but in exchange for that safety, you’ll have to be willing to accept a correspondingly modest return.

T-Notes and T-Bonds pay a rate of interest every six months, or twice per year until the bond matures. T-Bills operate a bit differently. They’re issued in the primary market at a discount to their face value of $1,000 per bill. Instead of earning a rate of interest, you’d get $1,000 when the bill matures.

Another form of Treasurys are Treasury Inflation-Protected Securities or TIPS. TIPS are market securities whose principal is tied to changes in the Consumer Price Index, or CPI. TIPS principal increases with inflation (rises in the CPI) and decreases with deflation (decline in the CPI). TIPS pay a fixed rate of interest twice annually, and that interest also fluctuates with current inflation levels.

Think of it this way: if inflation does kick in as you’d feared, your TIPS principal would increase accordingly. Then you’d be paid a fixed rate of interest on a higher principal, effectively resulting in a higher rate of interest. You can buy TIPS in five-, ten- or twenty-year maturities in increments of $100 each. Upon maturity you get either the inflation-adjusted principal or the original principal.

Treasurys are virtually risk-free

Treasurys can be considered the Cadillac of secure loans. The Treasury has never defaulted on a federal loan, and its debt securities are considered virtually risk-free – as safe as cash. (However, the Treasury’s credit-worthiness won’t prevent losses if selling your bonds before maturity.) In fact, Treasurys are considered so bulletproof that risks associated with debt securities the world over use Treasurys as the prime benchmark of safety. Ultimate safety comes with trade-offs, however. Treasurys pay the lowest rate of interest of all bond types in exchange for being an extremely sure thing.

Like other Treasury bonds, TIPS are theoretically default risk-free. However, you do face significant risks in the event that deflation occurs. Deflation, or a drop in the CPI, means your principal would be correspondingly adjusted downward, so your interest payments would be less than if the CPI had stayed flat or showed evidence of inflation. In a deflationary environment, then, TIPS products could expose you to significant capital losses. At maturity, though, a useful safeguard kicks in: if the adjusted principal is less than the security’s original principal, you’d be paid the original principal. However, no such safeguard exists against deflation before maturity.


Time Horizon

Treasurys are used 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 the money.

Some investors gradually shift from higher-risk investments like stocks or other bonds to Treasurys as the time horizon for a given financial goal approaches.


When to Get In

You might buy Treasurys if:

  • You want to transition assets into a low risk investment as your time horizon for reaching a financial goal approaches.
  • You are super-nervous about the stock market.
  • You don’t have a clear outlook on the market as a whole.
  • You expect interest rates to decrease in the future.
  • You expect inflation to rise and invest in TIPS.


When to Get Out

Treasurys are usually purchased with the intention of holding them until maturity. That said, you might liquidate your holdings in Treasurys if:

  • You need the money for a specific purpose.
  • You are comfortable with the risk-reward relationship offered by the stock market.
  • You have a clearer outlook on the stock market.
  • You expect interest rates to increase.
  • You expect inflation to stabilize or deflation to occur and liquidate TIPS.
  • The bond reaches its maturity date.


Investment Management

Treasurys are usually purchased with the intention of holding them to maturity, which makes for a low-maintenance investment. The interest payments you receive while holding T-Notes or T-Bonds deserve more attention. Each individual coupon payment may not seem like much money. However, stashing these payments in a savings account over the course of a year can amount to a nice chunk of change. Consider reinvesting these funds to purchase additional bonds on an annual basis.


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 at that time. 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. Be sure to choose a bond investment that is in-line with your risk tolerance.


Ally Invest Margin Requirements

Obviously it’s important to estimate in advance how much margin interest cost you expect to incur on every margin trade, because you’ll need the interest you receive from your bond to outperform these costs. Margin rates vary from account to account. The greater the amount you borrow, in general, the lower your rate will be. You can view the lower rates as a volume discount.

When you understand the risks, you can buy Treasurys on margin as long as you have a margin account which meets the minimum equity requirement of $2,000. Not all bonds may be purchased on margin. For Treasurys the initial and maintenance margin requirements are usually 10% of the current market value. These requirements could increase due to market volatility, fluctuations in the bond’s value, concentrated positions, trading illiquid bonds and other factors.

If the equity in your account is not sufficient to meet these requirements, you will be required to increase your cash or marginable security holdings to ensure you have sufficient collateral to repay the loan. When this happens, it’s known as a margin call, and Ally Invest will instruct you to adjust your holdings over the life of the investment.


Tax Ramifications

Investments in Treasurys are taxable at the federal level, but exempt from state and local taxes. Consult your tax adviser for the low-down on this important topic.


Ally Invest Tip

Use the Rule of 100 or Rule of 120 with your asset allocation plan.

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