Definition of Treasury bonds, types, how to invest

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  • A treasury bill is a type of debt obligation distributed and guaranteed by the US government.
  • Investors can buy several types of Treasury securities depending on their investment horizon.
  • Some treasury bills pay interest gradually while others pay at maturity.
  • Visit Insider’s Investment Reference Library for more stories.

A Treasury bond is a government-backed debt obligation issued by the US Treasury. Several types of securities, including bills, notes, bonds and more, fall into this category. Depending on the type of bond you buy, maturities range from four weeks to 30 years, and interest can be paid regularly or at maturity.

“Treasury bills are all pretty safe, but they don’t perform well,” says Jim Pendergast, senior vice president of altLINE, a division of The Southern Bank Co. “The key is to find a treasury bill. that keeps your money safe while keeping you abreast of inflation. “

Before buying a Treasury bond, it is important to understand the different types, how they work, and some of their pros and cons.

Understand how treasury bills work

When you buy a Treasury security, you are essentially lending money to the government, which promises to pay you back on a certain date.

The wide range of maturities available allows you to choose the type of security that matches your investment objectives. Once you have purchased a Treasury security, you will need to hold it for at least 45 days, but you can redeem it at any time thereafter. Of course, investors receive the maximum return while waiting for the maturity date. Investors earn interest as long as they hold the security, either periodically (eg every six months) or at the time of redemption.

Interest you earn on treasury bills is subject to federal income tax. Increases in the principal value may also be taxed. But you won’t pay state or local income taxes.

Some investors hide their emergency funds in treasury securities because they are safe and liquid. However, you can pay a penalty if you redeem before maturity. Plus, “you could get the same or similar interest rate on a high yield savings account that you can access anytime,” says John Mendes, CPWA at Rise Wealth Strategies. Therefore, a savings account might be the way to go if you prioritize

liquidity
with no additional steps involved.

What are the different types of treasury bills?

While you may hear the term treasury bill applied to any government title, there are actually several types. The main differences are the maturity date of the securities and the method of payment of interest.

“Many argue that keeping up with inflation is the best strategy when choosing your treasury bills,” Pendergast said. “However, there are times when your investment does not reflect inflation correctly. Inflation rates are based on CPI results, which means they measure averages.”

Here are the different types of treasury bills:

goods of treasure maturity in four, eight, 13, 26 or 52 weeks. They are sold at a discount, which means you can buy one for less than its face value. But you receive the full face value (plus interest) at maturity. These are “known to have extremely low yields,” Pendergast explains.

treasury notes mature within two to 10 years and pay interest every six months. They are sold at a discount, coupon, or premium, which means the price may be less than, equal to or greater than the face value of the ticket.

treasury bonds are also sold at a discount, coupon or premium price and expire in 20 or 30 years. Bondholders receive interest every six months.

Inflation-protected Treasury securities (TIPS) maturity within five, 10 or 30 years and pay interest every six months. TIPS can help you protect your investment against inflation, as capital increases with inflation. (Although it also decreases with deflation.) At maturity, you receive either the Adjusted Principal or the Initial Principal, whichever is greater.

Variable rate bonds (FRN) matures in two years and pays quarterly interest. Interest payments increase or decrease based on the discount rates on 13-week treasury bills. These are sold at a reduced, coupon or premium price. “Most FRNs present a risk of falling,” Pendergast explains. “Sometimes interest rates drop, making it an unstable choice for investments. “

Separate trading of registered interests and principal of securities (STRIPS) are only available through private financial institutions.

Here’s how STRIPS work:

  • The business begins by taking an eligible treasury bill, bond, or TIPS, and separates coupons (interest payments) from principal.
  • They then sell the coins to investors at very favorable prices.
  • Investors can then redeem the security for full face value at maturity.

Advantages and disadvantages of treasury bills

Treasury bonds have their pros and cons, so consider these points before investing:

Advantages

  • Credit quality: Treasury securities are guaranteed by the US government, so they are generally considered to be of the highest credit quality.
  • Fiscal advantages : Interest you earn is subject to federal income tax, but not state or local income tax. However, you may need to pay capital gains taxes.
  • Liquidity: Investors can buy and sell Treasury securities both at regular auctions and in the secondary market. The exact price depends on their coupon rate, compared to the prevailing interest rates.
  • Choice: Depending on their needs, investors can buy Treasury securities in various structures with maturities ranging from four weeks to 30 years.

The inconvenients

  • Lower yield: You will generally earn less interest on Treasuries compared to other riskier securities.
  • Tax considerations: If you buy a bond at a discount and hold it until maturity or sell it at a profit, that capital gain will be subject to federal and state taxes.
  • Interest rate risks: Like all bonds, Treasury bonds are subject to price volatility due to changes in market interest rates.
  • Inflation risk: Interest earned on Treasury securities may not keep pace with inflation (with the exception of Inflation-Protected Treasury Securities, or TIPS).
  • Credit or default risk: All bonds also carry default risk, so Treasury holders should monitor their investments for signs of increasing default risk.

The major disadvantage of Treasury securities is their low yield.

“The interest rate risk is real,” says Alexander Campbell, registered investment advisor and chartered investment trustee at AG Campbell Advisory LLC. But it’s wise to remember that “fixed income is an important asset class in the management of our investment portfolios,” says Campbell. “It’s often the fixed income component that allows us to invest our other long-term funds in equities.”

How to buy treasury bills

Treasury securities are available either through the US Treasury or from a private financial services company.

Buy from the US Treasury

You can purchase newly issued Treasury securities directly from the source at TreasuryDirect.gov. After creating an account, you will place a bid at one of the auctions held regularly. T-bill auctions are held weekly, T-bill auctions are held monthly, and T-bill auctions take place four times a year (the first Wednesday in February, May, August, and November). The minimum redemption amount is $ 100 for each type of security.

During the auction, there are two ways to place a bid:

  • Non-competitive tender: When you make an offer, you agree to accept the interest rate decided in the auction. In exchange, you are guaranteed to have your offer accepted and you will be paid face value when due.
  • Call for tenders: You can also specify the interest rate you want to charge for the Treasury, but your bid will only be accepted if it is less than or equal to the rate set by the auction.

Buy through a bank or broker

You can also buy Treasury securities through a financial institution, such as a bank or brokerage house. Each institution sets its own minimum buy-in, so you may need to invest more than you would at TreasuryDirect. You have two main options when purchasing a security through a private company:

  • The firm buys on the government site. The financial institution will monitor TreasuryDirect auctions and bid for you on a newly issued security. This process is simple, but you can pay a fee for the convenience.
  • The company buys on the secondary market. The financial services company will purchase an existing treasury security for you in the secondary market. You might also have the option of purchasing a treasury bond mutual fund or an exchange traded fund (ETF) through the brokerage house. But with all of these options, commission charges may apply.

The financial report

Treasury securities are very low risk investments with varying maturities and interest payments. They are also liquid because investors can sell them for cash at any time as long as the markets are open. But since these investments typically pay less than stocks and some other assets, investors should consider diversifying to limit risk and make their money grow at the same time.


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