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What You Need to Know About US Treasury Bonds

What You Need to Know About US Treasury Bonds

US Treasury bonds, nicknamed “T-bonds,” are an investment option. When you purchase US Treasury bonds, you are actually loaning money to the United States government. In exchange for the loan, the government pays the bondholder interest. 

Although bonds do not generate large sums of money for the investor, they are considered a low risk investment because the government will not default on a bond. This makes Treasury bonds an ideal investment for certain individuals and a poor choice for others.

Purchase

There are two ways to purchase Treasury bonds, through the government website, treasurydirect.com, or through an outside broker, bank or dealer. When you purchase Treasury bonds directly through the government, you’re placing a non-competitive bid at a monthly government auction. 

When purchasing Treasury bonds from an outside source, you’re placing a competitive bid based on the return or yield you’re willing to accept. When bidding directly through the government, you have the ability to purchase the exact amount of Treasury Bonds you are interested in buying, and elect to invest only in Treasury bonds. 

However, you must accept whatever yield is decided through the auction. The advantage of purchasing through an outside source is that you can select the minimum yield and only buy the Treasury bonds if your requirement is meant.

The disadvantage is that you may not be able to purchase any bonds, or that you will end up with another auctioned form of government security such as a Treasury note or Treasury bill. 

Amount

Treasury bonds are available in $100 increments starting at $100. You can purchase up to $5,000,000 in Treasury bonds at a single auction. The purchase price may be more or less than the face value of the bond. 

However, these investments are still appealing when the interest rate is high, because the bond will still offer a yield for the investor.

Interest and Maturation

Treasury bonds generate interest every six months until the bond matures. It takes a Treasury bond 30 years to mature. Maturation means that a bond can be redeemed for its face value. 

However, Treasury bonds can be resold prior to maturation, and there is a strong market for them, so your money is not necessarily locked down until a bond matures. 

Yield

Subtract the money you paid for the bond from the bond’s face value plus the amount of interested generated through the bond, and you’ll know the yield. Essentially, Treasury bonds follow the law of supply and demand. 

When more people invest in bonds, the yield will be lower, but when fewer people invest, the yield will be higher. This is because rate of the yield is determined through the auction. If there are few bidders, they can set the yield higher, because other parties will not offer to purchase the same bond for less. 

If there are more bidders, then the yield will come down because people are willing to accept a lower yield to make the investment. In a depressed economy, people are more likely to invest in bonds because they are viewed as a safe investment. 

In a weak economy, the chances of inflation and high interest rates are much lower making bonds a very safe investment. With the large number of potential investors, the yield on bonds is lower.

Taxation

Interest earned through Treasury bonds is taxed by the federal government, but exempt from local and state taxes. You must file a 1099-INT with the IRS during tax season to report your interest earnings. You can also have the government automatically withhold a percentage of your interest, so you won’t owe money when taxes are due.

Loss Potential

Treasury bonds are not guaranteed to keep up with interest rates and inflation. Thus, if the inflation rate or interest rates go up, bonds can lose value. For example, say you purchase $15,000 in bonds that can buy a car in the year 2011. 

Thirty years later, you cash in your bond and the face value plus interest has generated $18,000. However, because of inflation, an equivalent model car now costs $30,000. Although you have made money beyond your initial investment, you have lost rather than gained in the long term, because you could have used the money to make other investments that would have kept pace with inflation.

Effect on Mortgage Rates

Treasury bonds are used when setting fixed mortgage rates. The higher the yield offered on bonds, the higher the fixed 30-year mortgage rate. When many people invest in bonds, the yield goes down, and mortgage rates similarly drop. Thus, the amount of overall investment in Treasury bonds impacts another key segment of the economy. 

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