Investing 101

What Types of Government Bonds Are Available to Investors?

A government bond is a type of security sold by governments that offers a fixed amount of interest each year, making it a relatively safe investment. So, what types of government bonds are available to investors? The variety of options can be overwhelming. Learn more about the types of government bonds that you can buy to evaluate the potential return and risks.

What are government bonds?

Government bonds are debt securities. Governments issue bonds to raise money. When you buy a government bond, you are essentially lending money to the government.

Each bond has a maturity date, which varies from one month to 30 years. When a bond reaches maturity, you receive the face value of the bond plus any interest that has accrued over the life of the bond.

Most government bonds are divided into categories based on their maturity date. They can also be freely traded. The price of existing bonds is based on the interest rate of the bond, the amount of time left until maturity, and the current interest rate for new bonds.

All types of government bonds are considered fixed-income investments, as the government is unlikely to default on its bonds.

Federal government bonds are issued by the US Treasury and purchased through actions. The US Treasury established a website, Treasury Direct, to provide investors with direct access to auctions.

Along with auctions, investors may purchase government bonds and municipal bonds as part of an exchange-traded fund (ETF) or money market account. Bonds are also available through brokers.

Treasury bills are short-term securities

Treasury bills are government bonds with maturity dates of a few days to 52 weeks. Bills with terms of 4 weeks to 52 weeks are auctioned on a consistent schedule through the US Treasury. They are purchased in increments of $100 with a minimum purchase of $100.

According to the US Treasury, treasury bills rarely sell at face value. They are typically sold at a discount, allowing you to earn a small return when the bill matures.

The return that you earn on treasury bills and other government bonds is subject to Federal taxes. You will need to include it on your federal return. However, interest from Federal government bonds is not taxed at the state or local level.

Treasury notes are intermediate-term securities

Treasury notes are government bonds with maturity dates between 2 years and 10 years. They are available in face values of $100 or more in increments of $100.

Unlike treasury bills, treasury notes (T-notes) earn interest. You earn a fixed rate of interest every six months until the T-note matures.

While T-notes are available in increments of $100, they are often sold with a face value of $1,000 or $5,000. The 10-year Treasury note is also one of the most closely monitored government bonds.

The financial experts at The Balance explain that the 10-year Treasury note is used as a benchmark for setting other interest rates. Lenders often use the yield on the 10-year treasury notes to set fixed interest rates for mortgages.

Treasury bonds are long-term securities

Treasury bonds (T-bonds) have a maturity date of 20 years or 30 years. As with T-notes, the government pays a fixed interest rate every six months. T-bonds also have a $100 minimum purchase amount and $100 investment increments.

As T-bonds are available with longer maturity dates, they tend to offer the best returns compared to other government bonds.

Treasury inflation-protected securities (TIPS) Are tied to inflation

Treasury inflation-protected securities (TIPS) are government-issued securities that are adjusted based on inflation and deflation. Inflation causes the principal value of the bond to increase while deflation causes it to decrease.

As with other US Treasury bonds, TIPS pay interest semi-annually. However, the interest payments are not fixed. The return is based on the adjusted principal value of the TIPS every six months.

According to brokerage firm Charles Schwab, TIPS are a smart investment for protection against rising inflation. However, the experts at Schwab also state that TIPS often provides a lower yield compared to other government bonds.

While you may not earn a decent return, the money that you invest in TIPS should closely keep pace with the value of the dollar.

TIPS are available with maturity dates of 5, 10, or 30 years. You may also invest in mutual funds or ETFs that hold TIPS. However, TIPS are prone to price fluctuations over the short term. As with most government bonds, you stand to gain more the longer that you hold on to the TIPS.

Savings bonds offer a fixed rate of interest

The US Treasury offers two types of savings bonds – Series I Savings Bonds and Series EE Savings Bonds.

Series I Savings Bonds are sold at face value and offer a fixed return. They have a minimum purchase of $25 when buying electronic bonds. Unlike other government bonds, you can still purchase Series I Savings Bonds in paper form.

The US Treasury allows you to buy Series I bonds when you file your tax return. You simply need to include IRS Form 8888. You can buy paper bonds in denominations of $50, $100, $200, $500, and $1,000.

The interest is not paid during the life of the bond. You earn interest when you cash the bond. If you cash the bond before five years, you forfeit interest from the previous three months. 

EE Savings Bonds pay interest based on the current market rates instead of providing a fixed return. You can purchase paper or electronic EE bonds. They are also guaranteed to double in value at 20 years.

After 20 years, if the yield has not doubled the face value of the savings bond, the government will make a one-time adjustment to ensure that it is worth twice what you paid.

Municipal bonds are issued through local governments

The previous types of bonds are issued by the US Department of the Treasury for the Federal Government. Municipal bonds are government bonds issued by counties, cities, or states.

There are three groups of municipal bonds:

  • General obligation bonds
  • Revenue bonds
  • Conduit bonds

General obligation bonds are not secured and come with greater risk, along with a greater return. Revenue bonds are often issued to pay for specific municipal projects and carry less risk. Conduit bonds are issued on behalf of private organizations, such as colleges or hospitals.

Municipal bonds have maturity dates of 1 to 30 years. You can buy municipal bonds through brokers, self-managed brokerage accounts. Municipal bonds are also available in mutual funds and ETFs.

How do you buy government bonds?

Government bonds are only available electronically. The US Treasury no longer issues paper bonds. However, you have multiple ways to buy bonds:

  • Directly from the US Treasury
  • Broker
  • Brokerage account
  • Mutual funds containing bonds
  • ETFs containing bonds

The process for buying government bonds through a broker or brokerage account varies depending on which firm you work with. Buying government bonds through a broker or self-managed brokerage account may include extra fees.

If you want to avoid paying fees, you can buy government bonds through the US Treasury’s Treasury Direct website. Keep in mind that the US Treasury does not sell municipal bonds.

You need to create an account before you can buy government bonds through Treasury Direct. Creating an account requires you to supply your social security number and a bank account. Government bonds are purchased electronically through the website.

The US Treasury sells bonds through auctions that are held 300 times per year. Most government bonds are sold on a fixed schedule while others are issued as needed to raise funds for the government.

You can browse available bonds based on the type of bond, maturity date, and yield. The maturity date and yield help you determine the potential return based on how long you may hold the bond before selling it.

Bonds are purchased using bids. You can use competitive bidding or noncompetitive bidding. With competitive bidding, you set the price you want to pay.

Noncompetitive bidders accept the price determined at auction. When the auction closes, the US Treasury awards bonds to noncompetitive bidders first and awards the remaining bonds to competitive bidders based on their bids.

Government bonds are also available through mutual funds and ETFs that hold bonds. Many mutual funds have diversified portfolios that may contain multiple types of government bonds.

Government bond ETFs typically hold a single type of government bond. For example, you can purchase a long-term treasury bond ETF, intermediate-term treasury bond ETF, or a short-term treasury bond ETF.

Conclusion

Should you invest in government bonds and what type should you buy? Government bonds offer a good way to diversify your portfolio with low-risk investments. The type of bond you buy typically depends on your savings goals.

If you need to access money within a few years, consider a short-term bond, such as a treasury bill or treasury note. Use treasury bonds when you can wait 10 years or longer for the bond to mature, as a lengthier maturity date results in better yields.

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