If you’re looking to expand your investment portfolio, government bonds are an excellent way to do so. Let’s talk about how to invest in government bonds and whether it’s worth the cost?
Investors can invest in government bonds from Treasury Direct, a bank, or a broker. Government bonds are available individually or as part of a mutual fund. Each bonds term length will vary between 10 and 30 years. Investors can hold a government bond until it matures or sell it for a higher price.
Before you purchase a government bond, there are several things to consider. Keep reading to learn more about how to invest in government bonds!
Government Bonds: What Are They?
Governments all across the world use bonds to fund their spending.
When someone purchases a government bond, they receive interest over time.
However, government bonds, though very reliable, tend to bring in (very) low interest.
Regardless of this, many still purchase these bonds.
Why Invest In Government Bonds?
Well, so long as the government remains, the bond owner knows that they’ll get their money back… and then some.
Since well-established governments rarely fail, investing in government bonds is a very low-risk activity. That said, there are certain things to look out for when investing in government bonds.
What To Look Out For When Investing In Government Bonds
First of all, you need to consider the interest and inflation rate.
If a bond’s interest rate is lower than the inflation rate, you’ll end up with less money than you started with when you cash in your bond.
In 2021, the inflation rate in the United States was 4.7%, according to Statista. The U.S. interest rate has steadily increased over the last decade. For this reason, you can assume it will continue to do so. Booooo
According to Bloomberg, the average yearly yield from government bonds is 1.83%. Always compare the inflation rate with average yearly yield to ensure that you’re actually making money off your investment.
When you earn interest off of government bonds, it is exempt from state and local income taxes. However, you will still pay federal income tax on any interest earned.
The amount and the frequency at which you receive interest from your government bond depends on the type of bond you have.
Government bonds are issued for a certain period of time between 10 and 30 years. When you purchase a government bond, you receive interest payments every year. After the bond matures, you cash it in to get back what you paid.
The Different Types Of Government Bonds And Where To Buy Them.
The United States Government issues four different types of bonds: Savings, Treasury Note, Treasury Bond, and Treasury Inflation-Protected Securities.
Before you invest, you should know the differences between the bond types. Each bond will vary as to where it can be purchased from.
Some common places to purchase a government bond are from Treasury Direct, your local bank, or from a broker. If you already invest in a mutual fund, you might already be investing in government bonds. If not, take a peek at our new index fund article.
Let’s take a closer look at each government bond below.
There are several types of savings bonds: Series EE, HH/H, and I. Currently the only ones being offered are Series EE and I Savings Bonds.
Series EE Savings Bonds can only be purchased online. Investors can purchase Series EE Savings Bonds in amounts between $25 and $10,000. According to Treasury Direct, all Series EE Bonds will double in value after 20 years. This is a great return for a practically risk free investment.
While Series EE Savings Bonds use a fixed interest rate, I Savings Bonds have an interest rate that adjusts with economic inflation. These bonds can be purchased online or via your IRS tax refund. Electronic bonds are available for amounts between $25 and $10,000; meanwhile, paper bonds are only available for amounts between $50 and $5,000. The current interest rate for these bonds is 7.12%.
I Savings Bonds mature after 30 years; however, you can cash one in earlier than that. That said, if you redeem an I Savings Bond before five years of ownership has passed, you forfeit the last three months of interest the bond accrued. Avoid penalties by holding an I Savings Bond for at least five years before redeeming it.
You only receive the interest earned on your I Savings Bond when you redeem it.
Treasury Notes are auctioned off to determine their amount and interest rate. The minimum amount that can be issued for a Treasury Note is $100; however, the maximum amount exceeds $4 million. Currently Treasury Notes can only be purchased through a bank or a broker.
Investing in Treasury Notes is a bit riskier than other bonds. At any moment, the note could be worth less than its face value.
When you own a Treasury Bond you receive interest payments every six months for either 20 or 30 years. Like Treasury Notes, the interest rate and purchase price for a Treasury Bond is determined at auction. Currently, you can only purchase a Treasury Bond through a bank or a broker. This bond is issued electronically.
Treasury Inflation-Protected Securities (TIPS)
As mentioned earlier, inflation could leave you with less money than you started with when investing in government bonds. The government recognizes that inflation makes investments riskier and has implemented the Treasury Inflation-Protected Securities (TIPS) bond to attract more investors.
When you own a TIPS bond, you get paid interest twice a year. The interest rate and purchase price of a TIPS bond are determined at auction. You can purchase a TIPS bond for 5, 10, or 30 years.
So how do TIPS bonds keep up with inflation? The principal value of the bond varies with the Consumer Price Index. If the CPI increases, so will the value of your bond. You will then receive the earned interest based on this higher amount. The opposite can be said if inflation if the economy decreases.
When the TIPS bond reaches maturity, you redeem it for the adjusted principal. If your bond’s principal value has decreased, you will receive the amount you initially paid. However, if the bond’s principal value has increased (because inflation is on the rise), then you will receive the new amount. Of course, you can sell your TIPS bond to another person at any time.
Investing in TIPS bonds is the perfect way to make sure your investments don’t fall behind the interest rate.
How To Invest In Government Bonds | Summary
Hopefully this article cleared upon how to invest in government bonds.
If you’re dead set on investing in bonds then you’re all set!
All of these options, whilst more risky, have the potential to far outstrip your return on interest from a government bond. If you’re still unsure, consider using both investment types, splitting a percentage between each depending on your risk tolerance.
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