US Government Bonds-AKA “Treasury’s”:
I have written a couple of articles recently Bonds, about the Bond Bubble, and how a company uses a corporate bond sale to build a factory.
Today, I want to give a little more detailed explanation about how US Government Bonds work.
Government bonds are sold at auction to finance government debt. You can buy them yourself, although most buy bonds in a bond mutual fund. You might think, with as much government debt Washington has run up, that it wouldn’t be seen as a good investment. But money is pouring into government bonds right now.
Let’s go over a few US Government bond facts:
US Treasury photo by dbking
- The most common government bonds are the 2 yr, 3yr, 5 yr, 10 yr-called Treasury NOTES, and finally, 30 year Treasury BONDS. Don’t know why some are notes and some are bonds.
- The bonds come in increments of $100.00.
- The bonds come with an interest rate, that is paid out twice a year.
- At the end of the bond term-that 2-30 year period described above-the bond “matures”you get your principle (amount invested) back.
- You can buy the bonds yourself, online at Treasury Direct.
- The bonds can be sold on the open market-but may or may not be sold at face value. (depends on the going interest rate.)
A 5 year bond with an interest rate of 2% that is bought today for $1oo would pay you 1 dollar twice a year, for 5 years. Then at the end of the 5 years, you get your $100 bucks back. Now, most buy more than $100 at the time-there is a cost for purchase, and costs are higher, on a percentage basis, the less you buy. Unless you buy direct from the treasury, then the cost is zero.
The Ups and Downs of US Government Bonds
The complicated part of bond investing, occurs if you decide you need your money back before the bond maturity date-(5 years in the above example.) If new bonds are selling with an interest rate above the one you bought, your bond would be worth less-maybe 97.50, instead of 100 bucks.
Why?
Because why would someone buy your bond, at 2%, if they could buy a new one at 2.5%. This is what is known as interest rate risk. If the bond you bought, has a lower interest rate than other new bonds of the same type-then your bond value goes down. When you sell, you will get less than face value.
If you don’t need to sell, then it doesn’t matter-you will get your $100 at the end of the 5 year period.
On the other hand, if interest rates go down after you buy them-then your bond will be more valuable on the open market-you can sell it for more than the 100 bucks you bought it for. If you need money, then your investment is worth a little more than you thought-Bond Bonus, Baby!!!
Think Inverse With Bonds
So with Bond investing, you have to think inversely-kind of like with pituitary hormone levels. When your TSH or Thyroid Stimulating Hormone level is high, your thyroid function hormone level is too low (meaning your thyroid is under-active) , and vicey versey, as we say here in the south.
So similarly, when interest rates are dropping, your bond is worth more than face value, and when interest rates are going up, then your bond is worth less than face value.
Reader Questions and comments:
If this was a little difficult to follow-then re-read it a few times. Just like with memorizing muscles and nerves, remembering the ins and outs of investing can be a bit tedious. But before long-it will just click for you.
Now that I have confused you, what are your gov’mnt bond questions?
Tags: government bonds, investing in government treasury bonds, quick treasury bond tips, the ins and outs of treasury bonds
Love the metaphor with pituitary hormone levels! But seriously, these are some great tips for a topic that has always confused me a bit. Simplifies the concept a lot, and the biggest takeaway for me is that I didn’t realize how liquid government bonds are…didn’t know how easy it could be to sell a bond that has become more valuable due to lower interest rates.
The internet has made trading everything so much easier. Helps to level the playing field! At least a little.
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