What is a treasury bond (T-bond)?
A treasury bond, or T-bond, is a fixed rate debt security issued by the U.S. government. It has a long maturation period, usually greater than 20 years. T-bonds share the same advantages as many other bonds: when you buy a T-bond, you’re likely to have a very safe investment since these bonds are backed by the U.S. Treasury. T-bonds earn interest until maturity, when the investor receives their principal-—or initial payment—plus the final installment of interest they are owed. This total amount is called the face value. They are generally considered a benchmark for fixed income securities because they offer a risk-free rate and a low return.
Types of treasury securities
T-bonds are just one kind of treasury security. The three types of treasury securities are based on the type of maturity:
- T-bonds or treasury bonds come with a maturity of 20 or 30 years and have the highest interest rates.
- T-notes or treasury notes have maturities of between two and 10 years and tend to have lower interest rates than T-bonds.
- T-bills or treasury bills have a maturity date of between four weeks and two years from when they are purchased. They are sold at a discount to the face value of the bond, which means that investors earn the rest at maturity.
Longer-term government securities tend to have higher interest rates than shorter-term bonds because there is generally more uncertainty for longer time frames – what happens in five years is harder to forecast than what happens in five weeks. These long-term investments are used by some investors looking to save for retirement.
How do T-bonds work?
Most investors will purchase T-bonds on the secondary market, also known as the fixed-income market or bond market, or online at TreasuryDirect.gov.
T-bonds are first sold at auction. These bids can be competitive or noncompetitive. In noncompetitive bids, buyers may purchase up to $5 million in T-bonds, while in competitive bids, they may purchase 35% of the offering. These can then be bought and sold on a highly liquid secondary market—through a brokerage or other financial institution. As a result, prices for government bonds like T-bonds can fluctuate in the secondary market.
When you buy a T-bond, you make an initial payment that functions as a loan to the U.S. federal government. This payment is called a principal. The government then has a debt obligation to you, the bondholder, that it must repay.
Throughout the maturity of your T-bond, it will earn interest semiannually — the disbursements on this are called coupon payments. When maturity is reached, the owner is paid back the original cost of their principal, as well as the final interest payment that has been accrued.
Income earned from T-bonds is exempt from state and local taxes. You’ll only need to pay federal income taxes on interest payments from your T-bonds. Bondholders with Treasury bonds from the U.S. government can see the interest they’ve earned that year on their IRS Form 1099.
Meanwhile, taxes are the reason why these bonds are so reliable for investors. The government can use tax money to make sure that T-bond owners are paid back in full, making these investments essentially free of risk.
Rate of return
Treasury Bonds are low-risk, but this comes at a cost to investors: their yield tends to be relatively low. The interest rate on T-bonds as of November, 2022 is around 4.27%.
T-bonds are one part of the yield curve in the fixed-income market, which indicates the yield on investments held by the federal government. In general, the curve indicates that longer-maturity investments have higher yields, while shorter-maturity investments have lower yields. When this curve begins to indicate the opposite correlation, it tends to be a sign of economic slowdowns.
The rate of return is also based on the bond’s coupon rate, which is the portion of value repaid to investors every year.
To come up with the coupon rate, simply add the annual payments and divide by the par value, or value at issue.
Let’s say you hold a T-bond worth $100 at issue. You’ll receive $10 every 6 months. To determine the coupon rate, you’d do the following:
So your bond’s coupon rate would be 20%.
One reason T-bonds stand out is their long maturity. T-bond maturities are between 20 and 30 years. At the end of the maturity period, the bond’s owner is paid the full face value of the bond, which includes the original purchase price along with the last interest amount.
What are the pros of T-bonds?
The biggest advantage of a T-bond—similarly to several other types of government-issued securities—is the low risk associated with purchasing. There is almost no possibility of losing out when you buy a T-bond, because these bonds are backed by the credit of the U.S. government, which in turn has the authority to raise taxes in order to ensure sufficient payments.
In other words, T-bonds are great for investors who want to play it safe—maybe because the economy is going through a rough patch, or because the investor wants to safeguard cash for an important purchase like a child’s education. They can also help investors diversify their portfolios.
What are the cons of T-bonds?
The big disadvantage of T-Bonds is that they are a relatively low-yield investment. This tends to be true of government-backed securities: the low-risk factor also makes them pretty low-reward. If you’re looking to make a high-risk, high-reward purchase, corporate or municipal bonds might be a better option.
If interest rates go up—as have historically done over a long maturity period—bond prices will fluctuate. Over the course of the 30-year maturity for T-bonds, it’s likely that this will occur. They also are not inflation-protected securities, which means they may be outpaced by inflation.
For those looking to invest in inflation-protected bonds, i-bonds maybe a great option. Learn more about how to buy i-bonds in our comprehensive guide
Who should buy T-bonds?
As mentioned above, T-bonds are a low-risk investment. Many financial advisors suggest these savings bonds best for investors who want to be careful, not for those who want huge yields. If you’re concerned about the impacts of an economic rough patch, and want to play it safe until the storm passes, T-bonds may be a good option for you.
If you’re looking for other ways to invest for the long haul, consider Public’s Long Term Portfolio. It lets you lock in the investments you care about, so that you can invest for the future.
What to know before investing
If you’re planning to invest in T-bonds, these tips might help:
- Understand your long-term financial goals and whether this low-risk investment will help serve those goals.
- If you do decide to buy T-bonds, decide whether you’d like to purchase through a broker on the secondary market, or through an online auction at the TreasuryDirect site.
- Consider ETFs as a low-cost way to invest in Treasury bonds. Exchange-traded funds can help you invest in Treasury securities without the cost of buying bonds directly.