Treasury bonds are safe but offer lower returns than stocks or corporate bonds
Whether a Treasury bond is a good investment depends on what you need the money to do and when you need it. Treasury bonds are issued by the U.S. Department of the Treasury and backed by the full faith and credit of the U.S. government, which means the risk of the government failing to repay you is extremely low. That safety comes at a cost: the interest rate (called the yield) is lower than what you would earn from stocks, corporate bonds, or other investments that carry more risk.
A Treasury bond is a loan you make to the federal government. You give money now, the government pays you interest twice a year, and at maturity (which can be 20 or 30 years away, depending on which bond you buy) you get your original money back. The tradeoff is straightforward: you accept a modest return in exchange for knowing almost certainly that you will get paid.
Key Takeaways
- Treasury bonds pay a fixed interest rate set at auction, and that rate does not change even if market rates rise or fall after you buy.
- If you sell a Treasury bond before maturity, its price will fall if interest rates have risen since you bought it, meaning you could lose money.
- Treasury bonds are taxed as ordinary income at the federal level but are exempt from state and local income tax.
- Treasury bonds work best for money you will not need for 20 or 30 years, or as a ballast in a portfolio when you want to reduce overall risk.
How Treasury bond interest rates and prices work
When you buy a Treasury bond, you lock in an interest rate for the entire time you hold it. If you buy a 30-year Treasury bond paying 4%, you will receive 4% per year (paid in two installments) no matter what happens to interest rates in the broader economy. This is different from a savings account or money market fund, where the rate can change.
The catch appears if you need to sell before the bond matures. Treasury bonds trade on a secondary market, and their price moves in the opposite direction of interest rates. If interest rates rise after you buy your bond, new bonds will pay a higher rate, making your lower-paying bond less attractive to buyers. They will only buy it at a discount — meaning you sell it for less than you paid. If interest rates fall, the opposite happens: your bond becomes more valuable, and you can sell it for more than you paid.
This price movement matters only if you sell before maturity. If you hold the bond until it matures, you get your full original investment back regardless of what happened to interest rates in the meantime.
Treasury bonds compared to other fixed-income investments
Corporate bonds and municipal bonds typically pay higher interest rates than Treasury bonds because the issuer carries more risk of default. A company can go bankrupt; the U.S. government has never defaulted on its debt. That extra safety is why Treasury yields are lower.
High-yield savings accounts and certificates of deposit (CDs) currently offer rates that sometimes match or exceed Treasury bond yields, depending on the maturity and the current market. The difference is that savings accounts and CDs are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per account, and you can access your money without selling at a loss. Treasury bonds are not FDIC-insured, but they are backed by the government itself, which is considered safer. You also cannot easily access your money early without selling on the secondary market.
Stocks have historically returned more than Treasury bonds over long periods, but with much greater year-to-year swings. A Treasury bond's value is predictable; a stock's is not.
Tax treatment of Treasury bond interest
Interest you earn from a Treasury bond is taxed as ordinary income at the federal level, meaning it is added to your other income and taxed at your marginal tax rate. However, Treasury bond interest is exempt from state and local income tax. This can make Treasury bonds more attractive if you live in a state with high income tax, because you keep more of what you earn.
If you sell a Treasury bond before maturity and make a profit (because interest rates fell), that profit is taxed as a capital gain. If you sell at a loss, you can deduct that loss against other capital gains or, in some cases, against ordinary income.
When Treasury bonds fit into a portfolio
Treasury bonds are often used as a stabilizing force in a portfolio that also holds stocks. Because bond prices rise when stock prices fall (since both respond to interest rate changes, but in opposite ways), holding some Treasury bonds can reduce the overall swings in your portfolio's value. This is called diversification.
Treasury bonds also work well for money you know you will need at a specific future date. If you have $50,000 you will not need for 20 years, buying a 20-year Treasury bond locks in a known return and removes the temptation to spend the money or move it into riskier investments.
They are less suitable if you need the money within the next few years, because you may be forced to sell at a loss if interest rates have risen. They are also less suitable if your goal is to build wealth quickly, because the returns are modest compared to stocks over long periods.
How to buy Treasury bonds
You can buy Treasury bonds directly from the U.S. Department of the Treasury through its website, TreasuryDirect.gov. You set up an account, fund it with money from a bank account, and bid on bonds at regularly scheduled auctions. There is no fee to buy this way.
You can also buy Treasury bonds through a brokerage account (such as Fidelity, Charles Schwab, or Vanguard) or through a bank. These routes may charge a small fee, but they offer more convenience and the ability to buy bonds that are already issued rather than waiting for an auction.
Treasury bonds come in denominations of $100 and are sold in multiples of $100. You can hold them until maturity or sell them on the secondary market at any time.
Frequently Asked Questions
Can I lose money on a Treasury bond if I hold it to maturity?
No. If you hold a Treasury bond until its maturity date, you will receive your full original investment back plus all the interest payments you were promised. The only way to lose money is to sell before maturity when interest rates have risen.
What is the difference between Treasury bonds, Treasury notes, and Treasury bills?
They are all issued by the U.S. Treasury but differ in maturity length. Treasury bills mature in one year or less, Treasury notes mature in 2 to 10 years, and Treasury bonds mature in 20 or 30 years. Longer maturities typically pay higher interest rates because you are lending money for a longer period.
Should I buy Treasury bonds or keep money in a savings account?
It depends on when you need the money and current interest rates. If you need the money within a few years, a high-yield savings account is usually better because you can access it without risk of loss. If you will not need the money for 10 or more years and Treasury yields are higher than savings rates, a Treasury bond may lock in better returns.
Do I have to pay federal income tax on Treasury bond interest?
Yes, Treasury bond interest is taxed as ordinary income at the federal level. However, it is exempt from state and local income tax, which can make Treasury bonds more tax-efficient than other bonds if you live in a high-tax state.