Types of us Government Bonds

There are many different types of bonds to invest in, including government bonds, municipal bonds, and corporate bonds.  To raise money to run the country, the U.S. government borrows money from investors through the sale of bonds and in return pays interest to the investor for the use of his or her money. 

U.S. government bonds are considered safe and secure because they are backed by the U.S. Treasury, which is the issuer of the bond. The Treasury promises to pay back the face value of the bond at maturity.  Investors do not have to pay state income taxes on the interest.

The U.S. Treasury sells four types of bonds to individuals: (1) U.S. savings bond (2) U.S. Treasury bills (3) U.S. Treasury notes, and (4) U.S. Treasury bonds.   The interest rate varies according to the maturity of the bond, which means the length of time the investor holds the bond.   

Small denominational savings bonds are typically bought at banks and given as gifts to newborn babies, to newly married couples, or to mark an important occasion. You can invest in savings bonds that range from $25 to $5000 per bond and the purchase price is 50% of the face value of the bond. Interest from Series EE savings bonds is exempt from state and local taxes.  

U.S. Treasury bills, notes, and bonds have different maturities.  The T-bill has a short term maturity, up to one year.  Of these three types of bonds, short term bonds or T-bills usually pays the lowest interest rate, because it carries the least risk.  The interest is also called the discount yield, because if you pay $990 for a T-bill and get $1,000 at maturity, the difference is the interest or discount yield.   

U.S. Treasury notes are an intermediate debt obligation with maturities from two to 10 years.  U.S. Treasury bonds are also called “long bonds” because the Treasury bond is issued with a 30 year maturity. They are non-callable, which means they will not be called in, or pulled in, by the Treasury for 30 years.  The long bond can be traded on the secondary market, which means it can be sold to another investor.  The trade is between the two investors, and not the issuer, which is the U.S. Treasury.

You can buy any of the above government bonds from a broker or directly from the Treasury online at http://www.treasurydirect.gov. You can also invest in a bond fund that specializes in U.S. government bonds. Most bond fund managers are adept at laddering bonds so there are different maturity levels that help to minimize risk. Before you invest in any of the bond funds, check out the portfolio holdings, the fund’s past performance, and the fund manager’s track record.  Past performance does not guarantee future performance.

Zero coupon bonds are an interesting breed of bond. Zeros that are issued directly from the U.S. Treasury are called STRIPS. The zero coupon bond is also called a discount bond because it is sold at a price way below its face value. No interest is paid until the bond matures. The zero coupon bond will have a maturity date that could be well into the future. When it reaches maturity, the principal, interest, and interest-on-interest is paid to the investor. This is the kind of bond that a grandparent might buy for a young child, who will receive the money when he reaches college age.

Municipal bonds, better known as munis, are issued by municipalities, such as a town or city.  When they need money to build a bridge, tunnel, highway, or water treatment plant, the municipality borrows money from investors and gives them a bond that promises interest. No federal tax is paid on the interest you earn on munis. In many states, the bonds are also exempt from state taxes. When you buy a muni bond, it is important to calculate the tax-exempt yield on the bond, in order to compare the yield to a taxable bond. 

There is much to learn about bonds, but this can get you started.