How do Treasury bonds work? (2024)

Everybody needs a deep-pocketed relative, and Americans have Uncle Sam.

Uncle Sam, though, typically lives beyond his means. When the federal government borrows from its own citizens to pay for public works and other programs, it offers them an IOU in the form of Treasury bonds. These bonds are easy to buy and low-risk. As with all forms of fixed-income investments, it can be smart to include Treasury bonds as part of a balanced investment strategy.

What are Treasury bonds?

Treasury bonds are one form of government debt. The US Department of the Treasury borrows from the investing public through bonds that are repaid with a set interest rate, usually over a longer period. The bonds are currently offered with maturities of 20 or 30 years and pay simple interest every six months until maturity. When the bond matures — when its pre-set term is up — you get back all the money you invested in the bond. It’s important to note that Treasury bond yield is based on simple interest, so it does not compound.

How do Treasury bonds work?

Treasury bonds are packaged and sold through the Treasury Department. The proceeds from selling bonds fund long-term projects, like building roads and bridges. Because the borrower is the US government, which is unlikely to default, Treasury bonds are considered to be very low-risk investments. New Treasury bonds are issued four times a year, according to a schedule published online by the Treasury Department. Bonds of various maturities are also re-opened eight times a year, creating a chance for investors to buy into previously issued bonds.

When the bond matures, the Treasury Department automatically deposits the principal into the bank or investment account you have designated.

Benefits of investing in Treasury bonds

Patriotism aside, investing in Treasuries can be a cornerstone of a balanced portfolio, said Paul Brahim, a managing director at Wealth Enhancement Group and 2025 president-elect of the Financial Planning Association.

In their forties, many people start thinking about moving some of their retirement investments, primarily stock market investments, to a mix of stock and fixed-income investments, like bonds, because they become cognizant of market ups and downs, said Brahim. That’s the point where people often merge risk management into their portfolio design, as they want to hold on to and protect some of the market gains they have accumulated, having also experienced market losses.

Bonds and fixed-income investments “provide diversity relative to the volatility of equity markets, and that creates a chance to rebalance,” said Brahim.

Risks of investing in Treasury bonds

Your money is not at risk in Treasury bonds unless the US government defaults on its obligations to its creditors, which is highly unlikely. The real risk comes in not fully appreciating the costs of exiting the bonds early, which requires smart timing to sell when re-investment options are high enough to cover the transaction costs.

Another risk of investing in Treasury bonds is called interest rate risk. Just like other types of fixed-rate bonds, Treasury bond prices fall when market interest rates rise. For example, say new bonds with higher interest rates come to market while you own an older bond with a lower interest rate. In that case, your bond becomes less valuable because its interest rate is less desirable to investors. If you sell that Treasury bond before its maturity during a period of higher interest rates, you may not get as much for it as you originally paid.

Comparing Treasury bonds, notes and bills

The US Treasury offers a spectrum of short-, medium- and long-term options for lending to the federal government. Treasury bills have maturities of four weeks to a year, while Treasury notes have maturities that range from two to 10 years.

The Treasury Department also offers savings bonds, which are distinct from Treasury bonds. Savings bonds are structured to deliver a certain amount of return by a certain maturity date. For instance, EE bonds double the initial investment in 20 years, and the interest on I bonds is adjusted every six months to reflect inflation trends.

How to buy Treasury bonds

Treasury bonds, notes and bills can be purchased for as little as $100 directly from the US Treasury at the TreasuryDirect website. You can also buy Treasuries through investment advisors, investment firms and banks.

Key considerations before buying Treasury bonds

“If you have a specific use for a piece of money, you’re better served to buy a certificate of deposit (CD) or a Treasury that matures when you need that money,” said Brahim. “For specific spending needs, at a specific time, a CD or Treasury is safe” because you are sure to reclaim all the money you initially put in at maturity, along with the accumulated interest (minus interest you have withdrawn along the way). The key, he said, is to match the maturity of the bond or CD to the date when you expect to need the funds.

Treasury Bonds versus other investment options

In general, when stocks rise in value, bonds are less attractive because they don’t deliver the same returns as a heady stock market. But when the stock market is in the doldrums, or even losing, bonds rise in value because they offer a way to protect the gains you made in stocks when they were on the rise.

It takes planning, said Brahim, but a smart strategy is to sell bonds (if they are already set to mature) when the stock market is down and put that money into well-priced stocks. Then, when the stock market rises again, sell those stocks and move the gains into the next issuance of bonds with the intention of letting that money accumulate safely, he said.

The impact of Treasury bonds on your investment portfolio

The best way to take advantage of the guaranteed return of Treasury bonds, Brahim said, is to time the maturity for a long-term goal, so that the whole of the bond plus interest is available to fund, say, a child’s college education or retirement income.

But, he added, that strategy counts on buying and then holding the bonds. Because it can be complicated and costly to sell the bonds before they mature, a common strategy is to invest smaller amounts in bonds that have successive maturity dates. With the “laddering” strategy, a bond is always maturing, so cash is always becoming available. You can decide with each maturing bond if you want to take the cash for a spending or investing need or put it right back into the next issue of bonds.

Overall, Treasury bonds, along with other fixed-income investments, are “the great diversifier,” said Brahim.