U.S. Treasury Bonds, Bills and Notes: What They Are and How to Buy

U.S. Treasury bonds are fixed-income securities issued and backed by the federal government. Despite lower returns, these low-risk investments are sought-after because of their perceived stability and liquidity.

Tiffany Lam-BalfourDecember 16, 2020

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The United States and its economy have a broad reach. The U.S. has the largest and most active stock exchanges worldwide, U.S. dollars are frequently used in foreign exchange transactions, and more than $7 trillion in U.S. Treasury bonds are owned by other countries. Treasury bonds can be used to within any portfolio to add stability by balancing more volatile investments.

U.S. Treasury bonds are fixed-income securities issued and backed by the full faith and credit of the federal government, which means the U.S. government must find a way to repay the debt. Given the status of the U.S. government and its economy, Treasury bonds are considered low-risk investments that are generally considered risk-free when held to maturity. Relative to other higher-risk securities, Treasury bonds have lower returns, but these securities remain sought-after because of their perceived stability and liquidity, or ease of conversion into cash.

How Treasury bonds work

Types of U.S. Treasury bonds

Treasurys might sometimes seem confusing. You might have heard of Treasury bills, Treasury notes and Treasury bonds, but what’s the difference? The distinguishing factor among these types of Treasurys — actually, all types of bonds backed by the full faith and credit of the U.S. Department of the Treasury — is simply the length of time until maturity, or expiration.

  • Treasury bills (or T-bills): Short-term debt securities that mature in less than one year. Though T-bills are sold with a wide range of maturities, the most common terms are for four, eight, 13, 26 and 52 weeks.

  • Treasury notes (or T-notes): Intermediate-term debt securities that mature in two, three, five, seven and 10 years.

  • Treasury bonds (or T-bonds): Long-term debt securities that mature between 10 and 30 years.

  • Treasury Inflation-Protected Securities (or TIPS): Another type of Treasury bond, adjusted over time to keep up with inflation.

Risk vs. return

When financial advisors talk about asset allocation within a portfolio, it means investment dollars are spread among three main asset classes, or groups of similar investments. Stocks generally provide the greatest long-term growth potential but are the most volatile. Bonds can generate income and compared to stocks, usually have more modest returns and can help balance out volatility. Cash has the least risk and lowest return to buffer volatility or cover unexpected expenses.

With investing, usually the higher the risk, the higher the return. This applies here: Bonds usually have less risk versus stocks, which means they usually generate lower returns versus stocks. Because Treasury bonds are typically safer than other bonds, that also means investors will likely see lower returns.

One risk related to bonds is credit risk, or the likelihood for the bond issuer to default or not be able to pay you back. When you purchase a Treasury bond, you are, in essence, loaning money to the federal government. Given that the U.S. government is on the hook to repay your loan, the credit or default risk is extremely low. The Treasury Department can always raise taxes or use other methods to make good on repaying its debt to you.

Another risk to understand is interest-rate risk. Bond prices typically have an inverse relationship with interest rates. When interest rates rise, usually bond prices come down, and vice versa.

If you purchase a bond and later interest rates rise, you are locked into receiving a return less than what you would receive by buying a new bond at a higher interest rate. So the price, or market value, of your bond falls because your bond is now worth less. On the other hand, if you purchase a bond and later interest rates drop, the price of your bond rises because you’ve locked in a higher return than if you purchased a new bond at the lower interest rate.

You can see this play out with the returns on Treasurys under normal market conditions. The shorter the time frame, the lower the expected return, because there’s less risk of interest rates changing too much. That means T-bills have the lowest returns compared with T-notes or T-bonds. The longer the time till maturity, the greater the chance that interest rates could change, hence greater investment risk and volatility.

Why Treasury bonds are important

Proceeds from the sale of Treasury bonds go hand in hand with tax revenues to help the federal government finance its operations and repay outstanding U.S. debt.

As a longer-term bond, the 10-year Treasury bond is also used as a gauge for investor sentiment on the economy.

10-year Treasury bond and 10-year Treasury yield

A yield is a measure of the return an investor receives from a bond. Similar to the inverse relationship that bond prices have with interest rates, bond prices usually have an inverse relationship with their respective yield.

Because Treasurys are considered a safe investment, demand is greater when investors are concerned about the state of the economy, which means Treasury bond prices rise, and their respective yields come down.

On the flip side, when the economy heats up and people are not as risk-averse, investors likely favor higher-earning investments over safety and stability. Treasury bond prices come down, and their respective yields increase.

The 10-year Treasury yield is widely followed because it acts as a benchmark for longer-term interest rates, affecting other bonds, mortgages, car loans, personal loans, student loans, savings rates, etc.

How to buy Treasury securities

Similar to other stocks and bonds, you can purchase Treasury bonds either individually or as a collection of securities through mutual funds or exchange-traded funds, or ETFs. Although investors will owe federal taxes on Treasury bonds, one perk is that the interest generated from owning Treasurys is state and local income tax-free.

Buying individual bonds can make sense when you’d like to pinpoint a specific time frame to receive the bond’s repayment. Examples include using bonds as a lower-risk way to earn some interest on money set aside for a certain purpose — think a wedding, tax or tuition payment next year — or as a way to generate a predictable income stream in retirement.

You can purchase Treasury bonds directly from the Treasury Department through its website, TreasuryDirect, or through any brokerage account.

TreasuryDirect auctions Treasury bills, notes and bonds online. These auctions determine a bond’s price and yield using two types of bidding: either noncompetitive or competitive. Competitive bidders detail the terms they are seeking and can be allotted all, part or none of their request, whereas noncompetitive bidders accept the terms set by the auction.

T-bills are sold at a discount from the par amount, or face value, of the bill. Investors receive the full face value amount at maturity. For example, an investor could buy a T-bill for $950 but receive a face value of $1,000 at maturity.

Investors in longer-term Treasurys (notes, bonds and TIPS) receive a fixed rate of interest, called a coupon, every six months until maturity, upon which they receive the face value of the bond. The price paid for the bond can be greater (sold at a premium) or less than (sold at a discount) the face value, depending on market demand.

If you have no particular time frame in mind for repayment, investing in a mutual fund or ETF may be more appealing because of enhanced diversification from owning a collection of bonds.

Unlike individual bonds, bond funds do not have a maturity date and can therefore be subject to greater volatility. In a bond fund, a fund manager buys and sells bonds with varying terms, so your returns can be subject to market fluctuations when you sell the fund, instead of providing a predictable income.

If you’re looking for short-term maturities, a money market fund can provide exposure because they are usually made up of Treasury bills and other shorter-term debt securities.

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