How do government bonds work?

Start Investing
Andrew Goldman

Andrew Goldman has been writing for over 20 years and investing for the past 10 years. He currently writes about personal finance and investing for Wealthsimple. Andrew's past work has been published in The New York Times Magazine, Bloomberg Businessweek, New York Magazine and Wired. Television appearances include NBC's Today show as well as Fox News. Andrew holds a Bachelor of Arts (English) from the University of Texas. He and his wife Robin live in Westport, Connecticut with their two boys and a Bedlington terrier. In his spare time, he hosts “The Originals" podcast.

You’re not likely to be shocked to learn that the United States government doesn’t have enough dough on hand to pay its bills. Taxes just can’t cover its various obligations, and simply printing the money would lead to out of control inflation. It has to borrow the money to pay for national defense, payroll, not to mention the interest payments on its trillions in existing debt. By buying a treasury-issued bond, you could become one of the scores of lenders literally keeping the government’s lights on.

Government issued bonds are contracts stating the United States agrees to pay back a certain amount of money at an agreed upon interest rate, called the coupon rate, for a specified period of time, called the maturity date. Since there is virtually no risk that the government will default on its treasury bonds, there’s likewise a very low rate of return compared with other kinds of investments like stocks, which carry a much higher risk-reward tradeoff. The bonds are called different things corresponding to the length of their maturity dates — and come with cool nicknames that make them sound like bass players from classic rock bands.

Treasury bonds, or t-bonds, mature between one and ten years, and treasury notes, or t-notes — also called “long bonds” — mature in ten to 30 years, and both pay out interest twice a year. Treasury bills, or t-bills, mature within a year, and operate a bit differently, in that they pay no interest, but are rather are sold at a discount, so that you might buy a t-bill for $97 that will mature three months later and pay you its $100 face value. Certain government agencies, like the Government National Morgan Association (or Ginnie Mae) also issue bonds. Municipal bonds, or munis, are bonds issued by local governments to finance public projects like building bridges or roads. Munis are usually exempt from federal taxes, and state and local taxes if the bondholder’s a local. Government agency bonds are taxable at both the state and federal level; the IRS does not tax treasuries but states do.

Last Updated March 6, 2018

Trade stocks commission-free

Start investing