In general there are two broad categories investors can consider when looking to invest in government government bonds: Treasury bonds and municipal bonds. Both are options for investors seeking to build out the low-risk portion of their portfolio or just save money at higher, low-risk rates.

Government bonds can also be a great place to start if you are new to bond investing overall. Treasuries and municipals and are usually top low-risk bond options also considered alongside money market accounts, certificates of deposit, and high yield savings accounts.

Key Takeaways

  • Government bonds are low-risk, low-yield fixed-income securities that can be attractive to more conservative investors, or those looking for tax breaks.
  • TreasuryDirect is a website that allows investors to buy treasuries directly from the U.S. government at auction.
  • Some of the other ways to buy treasuries include ETFs, money market accounts, and from a broker.
  • Municipal bonds are issued by state and local governments or agencies and can provide tax-exempt interest income to qualified investors. These can be purchases through a broker or by way of managed fund or ETF.
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Government Security

Introduction to Government Bonds

First, let us acquaint ourselves with some common terms to be aware of when looking at government bonds:

  • Treasury bond: A security issued by the United States government.
  • Municipal bond: A debt security issued by a local or state municipality.
  • Maturity: The life of the bond.
  • Yield: The yield offered as a return on the debt security’s investment. There are several different types of bond yield and methods for calculating them.
  • Coupon: The amount of regular periodic interest payments.
  • Bond rating: A rating that is provided by a rating agency based on creditworthiness qualities and characteristics.

Government bonds are essentially debt obligations of governments. Federal (sovereign) bonds are issued by the federal government with the federal government’s single credit rating backing them all. As of July 2020, the U.S. federal government holds the highest AAA rating from Fitch, an Aaa from Moody’s, with an AA+ rating from Standard and Poor’s.

Both federal Treasury bonds and municipal bonds use the revenues from the bonds for financing government projects or activities. These government bonds also come with some special tax advantages that make them unique in the bond world overall.  The type of government bond you are looking for determines where you can purchase it, so you need to decide which type of bond you would like to buy first.

Buying Government Bonds: Treasuries

Treasury bond yields will vary by maturity. As of December 2020, the U.S. Treasury bond market offered the following yields:

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Image by Julie Bang © Investopedia 2020

The U.S. Treasury has made buying Treasury bonds easy for U.S. investors by offering the bonds through their website, TreasuryDirect. Here’s a step-by-step guide to using TreasuryDirect. TreasuryDirect account holders can also participate in Treasury auctions, which are conducted approximately 300 or more times per year.

The first step in the auction process is the announcement of upcoming auctions, which are generally declared four to five business days beforehand. This step discloses the number of bonds that the Treasury is selling, the date of the auction, maturity date, terms and conditions, eligible participants, and competitive and non-competitive bidding close times. Noncompetitive bids guarantee that investors will get the full purchase amount of the security at the yield determined during the auction by competitive bidding. Competitive bids specify the yield expected for security.

The second step of the auction process is the auction date when the Treasury reviews all bids received to ensure compliance with the full set of applicable rules. All compliant noncompetitive bids are accepted up until issue day, as long as they are appropriately postmarked.

The final step of the auction process is the issuance of the securities. Securities are deposited to accounts, and payment is delivered to the Treasury.

  • What you will need: a computer, internet connection, the treasurydirect.gov link, your social security number, and personal information, $100 to start investing
  • What to do: The Treasury makes TreasuryDirect pretty simple. All you need to do is:
  1. Go to the TreasuryDirect website
  2. Setup an account
  3. Start investing based on your maturity and yield preferences. The minimum for investment is $100. With $100 you can invest in Treasury bonds across the entire yield curve spectrum.

Additionally, investors can also buy Treasury bonds through a brokerage account. Charles Schwab, Fidelity, and Vanguard are a few of the top brokerages that offer Treasury bond investing. Some investors may also be able to invest in treasuries through their bank or local Federal Reserve.

Managed Funds

Many investors may turn to professional money managers for their Treasury investing. Like all asset classes, treasuries can be invested in through several mutual funds and exchange-traded funds (ETFs). A variety of government bond ETFs are available, including short-term treasuries, long-term treasuries, and TIPS. Most of these ETFs have modest annual fees, often below 0.20% per year.

Some of the most popular Treasury funds include:

  • SPDR® Portfolio Long Term Treasury ETF (SPTL)
  • iShares 7-10 Year Treasury Bond ETF (IEF)
  • iShares 3-7 Year Treasury Bond ETF (IEI)
  • iShares 1-3 Year Treasury Bond ETF (SHY)
  • SPDR® Bloomberg Barclays 1-3 Month T-Bill ETF (BIL)

Money Markets

You can also buy Treasury bills by investing in a Treasury money market mutual fund. Once you invest in one of these funds, buying and selling T-bills becomes easy. However, there are several significant limitations. You should probably open an account at the brokerage offering the Treasury money market mutual fund that you want. Treasury money market funds also tend to have high minimum investment requirements or high fees.

Buying Government Bonds: Municipals

Municipal bonds are the second type of government bond option. They are issued by state governments or local municipalities for funding infrastructure and government activities in these areas.

While they fall in the same broad category as treasuries, municipal bonds are a class of their own. They are government-sponsored but they have their own credit rating system which is similar to the standards for corporate bond credit ratings. Municipal bond issuers and bonds are rated from high to low quality by credit rating agencies—namely, Moody’s, S&P, Fitch, and Kroll. Individual bonds may also come with their own individual credit rating.

Below is a ratings chart provided by MSRB:

Municipal Bond Ratings.

Municipal bonds are also evaluated by maturity, ranging from 1-month to 30 years. Below is a look at the municipal bond yield curve for the AAA municipal market as of December 2020.

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Image by Julie Bang © Investopedia 2020

Finding comprehensive information on the full list of municipal bond investments can be somewhat more challenging than for treasuries. Beginning in 2008 the Municipal Securities Rulemaking Board (MSRB) introduced the website EMMA for providing investors with greater transparency on municipal bonds. EMMA provides full disclosure on all municipal bonds brought to market. It is not a platform for buying and selling municipals.

Four Channels for Investment in Municipal Bonds

Buying municipal bonds follows more traditionally with the standards in the bond market overall. Thus, most investors buy municipal bonds through brokerage accounts. However, in the municipal bond world, investors have a few choices. The MSRB suggests the following four channels for individual investors looking to buy municipal bonds:

  1. Full-service broker dealer. Can include companies like Schwab, Fidelity, and Vanguard. Offers communication with a broker dealer placing trades for you.
  2. Registered Investment Advisor (RIA): Usually an advisor from a specialty firm. Also offers communication with a broker dealer to place trades for you.
  3. Self-managed account. Can also include companies like Schwab, Fidelity, and Vanguard. Investors place their own trades and manage their own portfolios.
  4. Managed funds. Mutual funds and ETFs focused on municipal bonds.

These four categories can overlap slightly in their offerings. Serious investors looking to go deep in the municipals market may want to work with a full-service broker dealer or RIA that specializes in municipal bond investing which can allow for the potential opportunity to take part in primary issuance of municipal bonds. Generally, institutional investors comprise the majority of primary municipal market buyers. Most investors however will be happy with trading municipal bonds on the secondary market which can be done through full service brokers, RIAs, and self-managed accounts.

Managed Funds

Since municipal bonds are more complex than Treasury bonds, many investors choose to use managed funds, deploying the complex investment management to professionals.

Below are a few of the market’s most popular municipal bond funds:

  • iShares National AMT-Free Muni Bond ETF (MUB)
  • SPDR® Nuveen Bloomberg Barclays Short Term Municipal Bond ETF (SHM)
  • SPDR® Nuveen Bloomberg Barclays Municipal Bond ETF (TFI)
  • First Trust Managed Municipal ETF (FMB)
  • PIMPCO Intermediate Municipal Bond Active Exchange-Traded Fund (MUNI)

Tax Advantages

For federal bonds, the interest earned is generally exempt from state, and local taxes but subject to federal taxes. For municipal bonds, the interest earned is free from federal taxes. Municipal bonds are also tax free for investors investing in bonds from their home state. The municipal bond market also has offerings for investors who manage the alternative minimum tax.

Some Other Special Government Bond Considerations

Below are some answers to a few additional questions you may have when considering government bonds.

How Does the Government Bond Bidding Process Work?

Investors in treasuries can place competitive or non-competitive bids to obtain treasuries in the primary market. The Treasury has regularly scheduled auctions. Competitive bids are usually done through a broker. TreasuryDirect uses non-competitive bids.

Should I Buy a Government Bond?

Government bonds can be a great option for the low-risk portion of an investor’s portfolio. They can also be a great way to begin investing in the bond market overall with little risk. Yields on government bonds range from approximately 2.20% to 3.00%. Many investors look to government bonds as options for consideration along with money market accounts, certificates of deposit, and high yield savings accounts. Ultimately the investment in a government bond is generally based on investment goals, risk tolerance, and return.

Should I Get a Federal or Muni Bond?

The choice between federal and muni bonds is also generally based on investment goals, risk tolerance, and return. The markets for treasuries and municipal bonds are very different so many investors also consider the complexities of investing in each in their investing considerations.

What Government Bond Alternatives Are Available?

For investors seeking to deploy the management of federal and/or municipal bonds to professional investors, there can be many managed fund options to consider as alternatives to investing directly in treasuries or municipals. See the managed funds provided above for some options.