What are government bonds?

With low risk and fixed income, government bonds are a popular investment option

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When building an investment portfolio, one of the most important components you can choose is your asset allocation. Picking investments that align with your goals, investing timeline and risk tolerance will set you up for success. And more importantly, choosing the right investments will help you stick to your investment plan.

Investing in the stock market can help grow your wealth, but it’s also risky, which is why many investors choose to also invest in safer assets, such as bonds. Government bonds offer one of the safest investments available today, with guaranteed rates, solid returns and no additional fees.

Key insights

  • Government bonds are loans to the U.S. government in return for interest income.
  • There are several types of government bonds available, including savings bonds, Treasurys, municipal bonds and foreign government bonds.
  • Government bonds are seen as one of the safest investments available.
  • Government bonds are exempt from state and local income taxes.

How government bonds work

“When an investor buys a government bond, they are effectively lending the issuing government money,” explained Gerry Barrasso, president at United Financial Planning Group. “In exchange for this ‘loan,’ the government agrees to pay the bondholder a fixed set rate of interest, known as the coupon rate, over the bond's period. The interest is paid at regular intervals (annually, semiannually, etc.). At the end of this period, or ‘at maturity,’ the face value of the bond is returned to the investor.”

When the government issues a bond and investors purchase that bond, the money is usually locked up for a period of time while investors receive interest payments. The interest is paid out in the form of cash but does not typically compound back into the bond itself. This means if you buy a $100 government bond with a 5% interest rate, you’ll receive $5 per year until maturity, at which time you’ll also receive your principal investment back.

Government bonds are seen as one of the safest investments in the world, as the United States has rarely ever defaulted on bond payments (and there have only been four defaults in history, mostly around redeeming bonds for gold or silver). The U.S. Treasury market is backed by the full faith and credit of the U.S. government. In general, longer-term bonds have higher rates, unless interest rates are actively rising.

Government bonds are safer investments than corporate bonds, as corporations that issue bonds can go out of business and bondholders may not get paid back. As such, corporate bonds typically offer higher yields than government bonds, but with increased risk for investors.

» MORE: What is a good investment?

Types of government bonds

There are several types of government bonds available, each with their own unique characteristics. Here’s how the four main types of government bonds work:

Savings bonds

U.S. savings bonds come in two different types: EE Bonds and I Bonds. EE Bonds are guaranteed to double in value in 20 years. I Bond rates fluctuate with inflation.

Treasury bonds, bills and notes

U.S. Treasurys are bought at auction, allowing you to purchase at a discount and collect the full value at maturity. The interest rate is the difference between the bond face value (“par”) and your purchase price. There are three kinds of U.S. Treasurys available:

  • Treasury bills: Short-term bonds with a maturity of one year or less. These are zero-coupon bonds that are purchased at a discount to the face value and earn interest on maturity instead of getting regular coupon payments.
  • Treasury notes: Medium-term bonds with a maturity between two and 10 years. They issue coupon payments semiannually.
  • Treasury bonds: Long-term bonds with a maturity between 20 and 30 years. They issue coupon payments semiannually.
Municipal bonds

Municipal bonds are issued by state and local governments to raise funds for the needs of that municipality. The income from municipal bonds is generally tax-free at the federal and state level. There are two types of municipal bonds:

  • General obligation (GO) bonds are backed by local taxes (such as property taxes) or other general local government funds.
  • Revenue bonds are backed by the revenue from a local government project, such as a local stadium or road tolls.

While these bonds generally produce lower yields than U.S. Treasurys, their tax-exempt status can be a boost to investors who want to earn a solid return while offsetting income taxes.

Foreign government bonds

If you are looking to invest internationally, you can purchase foreign government bonds. These bonds may function similarly to U.S. bonds (paying interest payments to investors), but it’s important to understand the risks when investing internationally.

While the U.S. Treasury market is seen as one of the safest in the world, other country’s bonds may not be that well protected. International financial markets, political environments and government policies can affect international bond markets, so it’s important to stay up on current events if investing internationally.

You can typically buy international bonds through larger online brokers. You can also buy a mix of foreign bonds through a bond mutual fund or exchange-traded fund (ETF).

Benefits of investing in government bonds

Investing in government bonds is seen as a stable way to earn a fixed income with very little risk. Here are a few of the benefits of investing in government bonds:

  • Low risk: U.S. Treasurys are seen as a low-risk investment, and if held to maturity, you won't lose your money. Unless the U.S. government defaults on its debts, government bonds will be repaid.
  • Steady income: Many government bonds pay fixed payments, some on a monthly basis. This gives you a steady income that doesn’t fluctuate with markets.
  • Tax advantages: Government bond interest is exempt from state and local taxes.
  • Easy to resell: The U.S. government bond market is the most liquid market in the world, meaning there are plenty of buyers and sellers available. You can resell your bonds as needed on the secondary market.
  • Available through ETFs: You can invest in government bonds through ETFs from most major brokerage firms. This makes it easy to own a diversified mix of government bonds with very low fees (compared with managed mutual funds).

» MORE: Capital gains vs. investment income

How to invest in government bonds

There are several ways to invest in government bonds:

  • U.S. Treasury: You can purchase government-issued bonds directly from the U.S. Treasury by going to TreasuryDirect.gov. You can purchase Treasury bills, notes or bonds.
  • Broker: Most major investment brokers sell government bonds and bond funds for minimal trading fees. Companies like Fidelity and Charles Schwab have a large selection of both individual bonds and bond funds.

It’s important to consider your risk tolerance and investing timeline before buying government bonds. Many government bonds have long maturities, locking your money up for up to 10 years (or longer). If you need access to your funds sooner, you may want to explore shorter-term bonds, such as Treasury bills. If you need immediate access to your funds, you may want to consider a high-yield savings account instead.

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Are government bonds taxable?

Government bonds are taxable on your federal tax returns, but may be exempt from state and local taxes. Certain municipal bonds may be completely tax-free at the federal, state and local levels. If you sell corporate bonds on the secondary market, you will owe taxes on any capital gains made from the sale.

How often do bonds pay?

Government bonds issue payments in different ways. Most offer monthly coupon payments for the duration of the bond. Others, like Treasury bills, allow you to purchase the bond below par value (at a discount), and then you receive the full value at maturity. Bond payments don’t typically compound, but are rather paid in cash to your account.

Are government bonds traded on exchanges?

Some government bonds can be traded on exchanges, but not all. Savings bonds are not available on exchanges, but Treasury bills, notes and bonds are, as well as Treasury inflation-protected securities (TIPS). And you can buy and sell government bonds through a broker much more easily than through Treasury Direct.

Are government bonds insured?

While government bonds aren’t insured, they are backed by the full faith and credit of the United States government. This means there is no risk of default or losing money when held to maturity unless the U.S. government shuts down or defaults on its debts.

Bottom line

Government bonds are popular due to increased yield and the low risks involved in owning them. If you’re a retiree or want to lower the risk of your investment portfolio, government bonds are a great option. But many government bonds lock up your money for quite a while, and it’s important to understand maturity dates and how these bonds pay out before investing.

While you can purchase government bonds directly through the Treasury Direct website, you may find it easier (and more flexible) to do so through an online broker. You can buy with no fees or commissions through most large brokers, and you can sell at any time, making it a more liquid investment than through Treasury Direct.

Article sources
ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
  1. The Hill, "The US has never defaulted on its debt — except the four times it did." Accessed Nov. 8, 2023.
  2. Treasury Direct, "About U.S. Savings Bonds." Accessed Nov. 8, 2023.
  3. Treasury Direct, "Treasury Bills." Accessed Nov. 8, 2023.
  4. Treasury Direct, "Treasury Notes." Accessed Nov. 8, 2023.
  5. Treasury Direct, "Treasury Bonds." Accessed Nov. 8, 2023.
  6. U.S. Securities and Exchange Commission, “Municipal Bonds.” Accessed Nov. 8, 2023.
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