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If you want to invest in government bonds there are two main options to choose from: Treasury bonds and municipal bonds. Both are good choices for investors seeking to build out the low-risk portion of their portfolio or just save money at higher rates without the volatility that comes with investing in stocks.
Government bonds can also be a great place to start if you are new to bond investing overall. Treasuries and municipals are two of the top low-risk bond options.
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.
- Treasures can also be purchased from a broker or via an ETF or money market account.
- Municipal bonds are issued by state and local governments or agencies and can provide tax-exempt interest income to qualified investors.
- Municipal bonds can be purchased through a broker or via a managed fund or ETF.
Introduction to Government Bonds
Government bonds are essentially debt obligations issued by federal, state, or local governments. Some common terms associated with them are:
- 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 different types of bond yield and methods for calculating them.
- Coupon: The amount of regular periodic interest payments
- Bond rating: A rating provided by an agency based on the creditworthiness of the bond’s issuer
Federal (sovereign) bonds are issued by the federal government with the federal government’s single credit rating backing them all. In July 2020, the U.S. federal government held the highest AAA rating from Fitch, an Aaa from Moody’s, and an AA+ rating from Standard and Poor’s. In August 2023, Fitch downgraded U.S. sovereign debt from AAA to AA+ in response to what the agency saw as an erosion of stable governance and a poor long-term outlook for the federal budget.
Bonds are considered a lower-risk investment than stocks. Other low-risk investment options include money market accounts, certificates of deposit, and high-yield savings accounts.
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.
How To Buy Treasury Bonds
Treasury bond yields will vary by maturity. As of February 2024, the U.S. Treasury bond market offered the following yields:
The U.S. Treasury has made buying Treasury bonds easy for U.S. investors by offering the bonds through their website, 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.
To participate, you will need:
- A computer
- An internet connection
- The treasurydirect.gov link
- Your social security number and other personal/banking information
- $100 to start investing
Investing through TreasuryDirect is straightforward. First, set up an account at the TreasuryDirect website. Once you’ve created an account, you can 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 will need to open an account at the brokerage offering the Treasury money market mutual fund that you want, which may be different than the brokerage you normally use. Treasury money market funds also tend to have high minimum investment requirements or high fees.
How To Buy Municipal Bonds
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 the credit rating agencies namely, Moody’s, S&P, Fitch, and Kroll. Individual bonds may also come with their own 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 February 2024.
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 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:
- Full-service broker-dealer: Can include companies like Schwab, Fidelity, and Vanguard; offers communication with a broker-dealer placing trades for you
- Registered Investment Advisor (RIA): Usually an advisor from a specialty firm; also offers communication with a broker-dealer to place trades for you
- Self-managed account: Can also include companies like Schwab, Fidelity, and Vanguard; investors place trades and manage their own portfolios
- 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. This can allow for the opportunity to take part in the 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. This 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
The interest earned from federal bonds 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 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.
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 Government Bonds?
Government bonds can be a dependable option for the low-risk portion of an investor’s portfolio. Yield rates on government bonds can range from around 2% to over 5%. Many investors look to government bonds as low-risk options 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.
Are Federal or Muni Bonds a Better Choice?
The choice between federal and muni bonds is also generally based on investment goals, risk tolerance, and return. Both are generally lower-risk investments than stocks. However, buying municipal bonds can be more complex than buying Treasuries, so newer investors may prefer to begin with federal bonds. If you already have an account with a brokerage that offers a municipal bond fund, you may decide that is an easy way to invest in government bonds.
The Bottom Line
Like other types of bonds, government bonds are fixed-income securities that offer low-risk, low-yield returns. Because they are offered by federal, state, and local governments, these bonds also come with tax advantages.
Federal bonds are backed by the federal government. They can be purchased through the TreasuryDirect website or from a broker. Municipal bonds are issued by state and local governments and can be purchased directly from a broker. Many brokerages also offer ETFs and money market accounts that invest in either federal or municipal bonds.