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What are Treasury bonds and how do you invest in them?

What we'll cover

  • Types of treasury bonds

  • Different ways to purchase them

  • Considerations when buying T-bonds

Investing is all about finding a balance between risk and reward. If you’re looking to balance out your portfolio with a relatively low-risk investment, you might consider Treasury bonds.

What are 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 — also known as Treasuries or T-bonds — is the umbrella term for different types of bonds issued by the U.S. Treasury. 

The Treasury has never defaulted on a federal loan, and its debt securities are basically considered as safe as cash. (There are some caveats though. For example, the Treasury’s creditworthiness won’t prevent losses if you sell your bonds before maturity on the secondary market.)

That safety does come with tradeoffs. Treasuries pay the lowest interest rate of all bond types in exchange for being lower risk. Therefore, the opportunity for gains is significantly lower than riskier investments.

Types of Treasury bonds

Treasury bonds are categorized by their length of time until maturity. The three main types of Treasuries include:

  • T-bills: The shortest-term variety which mature 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 yearsrm loans, which mature in 30 years.

TIPS, or Treasury Inflation-Protected Securities, are a special type of Treasury bond with a principal tied to changes in the Consumer Price Index (CPI), an index that measures inflation — as such, they are often seen as protection against inflation. TIPS pay a fixed rate of interest twice annually, and that interest rate can fluctuate with current inflation levels. 

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.

Like other Treasury bonds, TIPS carry a low risk of default. But deflation, or a drop in the CPI, could expose you to significant capital losses. Rest assured that at maturity, a useful safeguard kicks in. If the adjusted principal is less than the security’s original principal, you’d receive the original principal. However, if you sell your TIPS before they mature, no such safeguard exists.

How to buy Treasury bonds

Here are three ways to buy Treasury bonds:

  • Noncompetitive bid auction: The most popular method for individual investors, a noncompetitive bid auction guarantees that you can buy the bond you want, but you must accept the interest rate set at the auction. You can purchase directly on (the U.S. Treasury’s portal) or you can invest through a brokerage, such as Ally Invest .

  • Competitive bid auction: This method is generally employed by experienced investors through a bank or brokerage. A competitive bid auction allows you to specify the yield, or interest rate, you will accept. Your bid will be accepted or rejected based on how it compares to the set interest rate of the bond. The maximum purchase you can make in a competitive bid is 35% of the Treasury’s offering.

  • Secondary market: This where Treasury bonds are bought and sold before the securities reach maturity. Treasuries that trade on the secondary market are more liquid and may see more price fluctuation based on current auction and yield rates.

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 Treasuries. 

  • Management: Usually, investors purchase Treasuries with the intention of holding them to maturity, which makes for a low-maintenance investment. But consider what you’ll do with the interest payments you receive. For instance, you might stash these funds in a savings account, such as an Ally Bank Savings Account , or reinvest to purchase additional bonds on an annual basis.

  • Tax ramifications: The interest earned on Treasury investments are taxable at the federal level but exempt from state and local taxes. Consult your tax adviser for more details.

  • Volatility: Fluctuation in bond prices is a factor of changes in interest rates and changes in credit quality. Increased time-to-maturity, higher coupons, longer duration and bonds trading at a discount can increase the volatility of bond prices.

Buying Treasuries can be an opportunity to add balance to your portfolio and mitigate some of the risk you incur with more volatile securities. 

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