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What are Treasuries & how do they work?

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When inflation and interest rates are high, it's normal to feel cautious about investments. But in this environment, there are low-risk investments available, like Treasury securities. They're considered among the safest investments because they're backed by the full faith and credit of the U.S. government.

Let's explore how Treasuries work, their pros and cons, and how you might work them into your investment strategy.

What are Treasuries?

Treasury securities, often referred to as Treasuries, are bonds issued by the U.S. Department of the Treasury to fund government operations and activities. Investors often tap into Treasury securities as a low-risk component of their portfolios.

When you invest in a Treasury security, you're essentially lending money to the government. In return, you receive regular interest payments over a specified period of time. At the end of the security's maturity, you'll also receive the return of the principal you initially invested.

What's the lifecycle of a Treasury security?

If you decide to invest in Treasuries, your investment will go through phases:

  • Issuance: The U.S. Department of the Treasury periodically auctions new Treasury securities to raise funds for government activities, such as infrastructure projects, social programs and debt servicing.
  • Purchase: Investors participate in Treasury auctions by submitting bids for the desired amount of securities they wish to purchase.
  • Interest payments: Once you own a Treasury security, you'll receive regular interest payments, typically on a semiannual basis. These interest payments can provide you with a source of income.
  • Secondary market trading: Treasury securities can be bought and sold in the secondary market before they mature. This allows investors to sell their securities to other investors if they need to access their funds before the security's maturity date.
  • Redemption: At maturity, the U.S. government redeems the Treasury security by paying the investor its full face value. The investor receives the principal amount along with the final interest payment.
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What are the different types of Treasuries?

Each type of Treasury security has its own characteristics and features. The main types include:

  • Treasury bills (T-bills): T-bills are short-term securities with maturities ranging from a few days to one year. They're sold at a discount to their face value, and when they mature, investors receive the full face value.
  • Treasury notes (T-notes): T-notes are medium-term securities with maturities ranging from two to 10 years. They pay a fixed interest rate (coupon) every six months until maturity.
  • Treasury bonds (T-bonds): T-bonds are long-term securities with maturities of more than 10 years, often up to 30 years. Like T-notes, they pay semiannual interest to investors, and the principal is returned to the investor at maturity.
  • Treasury inflation-protected securities (TIPS): The principal value of TIPS is adjusted based on changes in the Consumer Price Index (CPI). TIPS pay a fixed interest rate, and the interest payment is adjusted for inflation.
  • Treasury floating rate notes (FRNs): FRNs have a variable interest rate that's adjusted periodically based on a specified reference rate. FRNs are available with maturities of two years or more.
  • Savings bonds: Savings bonds come in two main types: Series EE and Series I. Savings bonds are purchased at face value and earn interest over time. Series EE bonds earn a fixed rate of interest, while Series I bonds earn a combination of a fixed rate and an inflation-adjusted rate.

What are the advantages & disadvantages of Treasuries?

The pros and cons of Treasury securities depend on the investor's financial goals, risk tolerance and investing preferences. Here's a closer look:

Advantages of Treasuries

  • Safety: Treasury securities are considered safe investments. They're backed by the full faith and credit of the U.S. government.
  • Stability: Treasuries provide a stable source of income, especially longer-term securities like Treasury notes and bonds.
  • Liquidity: Treasury securities are highly liquid and can be easily bought and sold in the secondary market. This liquidity allows investors to access their funds quickly if needed.
  • Diversification: Treasuries can serve as a diversification tool within an investment portfolio. Their low-risk profile, compared with other asset classes like stocks, can help reduce overall portfolio risk.
  • Inflation protection: Treasury inflation-protected securities (TIPS) provide protection against inflation. The principal value of TIPS is adjusted for changes in inflation.

Disadvantages of Treasuries

  • Lower returns: While Treasury securities are considered very safe, their returns are generally lower than riskier investments like stocks or corporate bonds. These lower returns may not keep pace with inflation over the long term.
  • Interest rate risk: The value of existing Treasury securities can be affected by changes in prevailing interest rates. When interest rates rise, the market value of existing securities can decline, leading to potential capital losses if sold before maturity. Prices of longer-maturity bonds often fluctuate more in response to interest rate changes than the prices of shorter-maturity bonds.
  • Market fluctuations: While Treasury securities are generally less volatile than other investments, their prices can still fluctuate in response to changes in market conditions, economic indicators and interest rate policy from the Federal Reserve.

How do you buy Treasuries?

Investors can buy Treasuries directly at TreasuryDirect, the U.S. government's portal for buying U.S. debt securities. Some brokerage firms, banks and credit unions also enable investors to buy Treasuries online through an account or through a trading desk over the phone.

Treasury securities are typically sold in specific denominations ($100, $1,000, $10,000 and so on), so you'll need to make sure your investment amount meets the minimum or maximum requirement. It's also important to compare fees and other features when choosing a method for buying Treasury securities.

How are Treasuries taxed?

While Treasury securities are exempt from state and local taxes, they are subject to federal income tax. The interest income earned from Treasury securities is taxed at the federal level, which can reduce overall returns for some investors.

TIPS bonds held directly or in taxable accounts can generate "phantom income" - taxable income based on the inflation adjustment to the bond's face value. Please consult a tax advisor before investing in TIPS outside of tax-advantaged accounts.

Treasury securities held in tax-advantaged accounts, such as IRAs or 401(k) plans, are generally not subject to current federal income tax. However, your withdrawals may be taxed at your ordinary income tax rate.

Should you consider Treasuries in your portfolio?

Before investing in Treasury securities, carefully consider your investment goals and risk tolerance. Treasuries are considered to be safe investments due to the backing of the U.S. government. However, their returns may be lower compared with riskier investments such as stocks or corporate bonds. They're just one type of investment you can add to your portfolio.

A Thrivent financial advisor can walk you through your options, helping you learn more about Treasuries and the role these securities might play in your overall financial strategy.

Thrivent and its financial advisors and professionals do not provide legal, accounting or tax advice. Consult your attorney or tax professional.