The United States government issues Treasury bonds to finance its operations or specific projects. Bonds are purchased at a discount from their face value. Interest payments on these bonds are made semiannually, and the bonds mature at their full face value. Treasury bonds are issued with minimum denominations of $1,000, and such a minimum purchase may cost the investor $950.
Interest on Treasury bonds, whether long term or short term, is taxed only on the federal level. Investors pay no taxes on the income at the state or local level. Because these bonds are government-issued, they are not at much risk of default.
Short-Term Treasury Bonds
When it comes to Treasury bonds, “term” refers to the maturity date when they reach full face value. Short-term Treasury bonds mature within three years. While these are the safest of Treasury bonds for investors, they also produce lower returns than bonds with longer maturities. However, if you are looking for an investment in which you won’t lose money, short-term Treasury bills indeed fit the bill.
You also won’t lose money if you put your savings into federally insured savings or a money market account, but the interest rates on these safe savings vehicles are not as high as Treasury bills. Because the maturities on short-term Treasury bonds are not that long, the investor enjoys more flexibility with the investment. It’s a good place to park funds while searching out more lucrative investment opportunities.
Medium-Term Treasury Bonds
Short- vs. long-term is not the only option for bond investors. There are also medium-term bonds, also known as intermediate-term bonds, which are those maturing within four to 10 years. These bonds fall in between short- and long-term Treasury bonds when it comes to yield and risk.
No matter the type of Treasury bond, the price and interest rate are determined at auction, according to Treasury Direct, where customers can buy and sell Treasury bonds online. The price of Treasury bonds depends on the interest rate and the yield to maturity.
As an example, if the yield to maturity is more than the interest rate, the price is less than the par value. When the yield to maturity is the same as the interest rate, the price and par value is the same. When the yield to maturity is lower than the interest rate, the price is above par.
Long-Term Treasury Bonds
Long-term Treasury bonds are those with maturities greater than 10 years. These bonds are issued with maturities of up to 30 years. The long-term Treasury bonds rate for a 30-year bond is often a full percentage point higher, or more, than the rates on five-year Treasury notes.
Long-term Treasury bonds carry a higher interest rate than short-term bonds because they also carry more risk. For example, inflation might reduce payment value, or interest rates could rise. When the latter occurs, bond prices fall.
Most bond investors should consider bonds with maturities up to 10 years. They may not earn as much interest as they would with longer-term bonds, but they also won’t face the risks and volatility inherent with these investments.
The Bond Portfolio
If you’re saving for retirement, you need stocks and bonds in your portfolio, but the ratio depends on how many years away you are from giving up the work world. Bonds offer income and stability, but stocks have the necessary long-term growth potential. When you’re young and can make up any stock market losses simply by waiting out the situation, keep the majority of your portfolio in stocks. As you get older, gradually shift some of your stock assets to bonds to ensure more stability and less volatility as retirement nears.