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Treasury notes (T-notes) are essential to a well-diversified investment portfolio. By including T-notes, investors can mitigate the risks associated with relying solely on stocks for their fixed-income needs. T-notes offer a valuable alternative, providing a steady income stream and a degree of stability that can help cushion the impact of market fluctuations.
T-notes are government-issued debt securities with maturities ranging from two to ten years. When you invest in a T-note, you essentially loan the government for a specific period. In return, the government agrees to pay you back the principal amount at maturity and periodic interest payments.
This article will guide you through the key features and considerations of investing in T-notes, helping you determine if they’re a suitable addition to your fixed-income strategy.
Key features of Treasury notes
Backed by the full faith and credit of the government. When you invest in Treasury notes, you’re essentially lending money to the government. These securities are backed by the full faith and credit of the government, meaning the government guarantees the principal repayment and interest payment. This backing significantly reduces the credit risk associated with T-note investments, making them one of the safest investments available in the fixed-income market.
Maturity dates. Treasury notes have a range of maturity dates, typically two to ten years. The maturity date is when the principal amount of your investment is repaid to you.
- Interest rate risk: Understanding how maturity affects interest rate risk is important. Longer-term T-notes generally have higher interest rate risk. This means that if interest rates rise after you purchase a T-note, the market value of your bond may decline. Conversely, if interest rates fall, the value of your bond may increase.
- Returns: The maturity of a T-note also influences its potential return. Generally, longer-term T-notes tend to offer higher interest rates than shorter-term ones to compensate investors for the increased interest rate risk.
Coupon payments. Treasury notes make periodic interest payments to investors, typically semi-annually. These payments are called “coupon payments” because, in the past, physical bonds had detachable coupons representing each interest payment. The coupon rate is the fixed interest rate that determines the amount of each coupon payment.
Taxation. The interest income from T-notes is generally subject to federal income tax. However, certain T-notes may be exempt from state and local income taxes.
Benefits of investing in Treasury notes
Low credit risk. As discussed earlier, Treasury notes are backed by the full faith and credit of the government. This means the risk of default is extremely low, making them a very safe investment option.
Liquidity. Treasury notes are highly liquid securities, meaning you can buy and sell them easily and quickly in the secondary market. This liquidity provides flexibility and allows you to access your investment when needed.
Inflation hedge (for longer-term maturities). While not a perfect hedge, longer-term T-notes can offer some protection against inflation. As inflation rises, the purchasing power of your money erodes. However, when inflation increases, interest rates typically rise as well. This can lead to capital gains on longer-term T-notes as their market value may decline.
Diversification. Treasury notes can be a valuable tool for diversifying your investment portfolio. You can reduce your portfolio risk by including T-notes alongside other assets, such as stocks. T-notes tend to have low correlations with stocks, meaning their prices don’t always move in the same direction. This can help to cushion the impact of stock market downturns on your overall portfolio.
Treasury notes vs. Treasury bills
You might be wondering how Treasury notes differ from Treasury bills. Here’s a breakdown:
Maturity:
- T-bills: Have shorter maturities, typically ranging from a few days to one year.
- T-notes: Have mid-range maturities, ranging from two to ten years.
Interest payments:
- T-bills: Sold at a discount to their face value. You buy the bill at a lower price and receive the full face value at maturity. The difference between the purchase price and the face value represents your interest earned.
- T-notes: Make periodic interest payments (coupons) to investors, typically semi-annually.
Key takeaway: T-bills are suitable for short-term investment needs and offer lower interest rate risk than T-notes. Conversely, T-notes are ideal for longer-term investment horizons and may offer higher potential returns, although they carry higher interest rate risk.
How to invest in Treasury notes
Directly from the Treasury Department. You can purchase Treasury notes directly from the government through TreasuryDirect, an online platform. This lets you buy T-notes at auction and hold them electronically in your TreasuryDirect account.
Through a brokerage account. Alternatively, you can buy and sell T-notes through a brokerage account. Brokerage firms provide access to the secondary market for T-notes, allowing you to buy and sell existing notes from other investors.
Consideration of ETFs and mutual funds. If you prefer a more diversified approach, you can invest in T-notes through exchange-traded funds (ETFs) or mutual funds specializing in Treasury securities. These funds offer instant diversification by holding a basket of T-notes with varying maturities.
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