Treasury bonds and notes are ideal for conservative investors interested in safety, income, and a break on their state and local taxes. But more aggressive investors might also be interest in them because they can help provide diversification for their portfolio. Treasury bonds would not be attractive to investors looking for a high level of income or capital appreciation.
Since 1925, long-term government bonds have provided an average annual return of about 5.3 percent. That is a better rate than money market funds, Treasury bills, and most short-term fixed income investments, such as certificates of deposit. However, T-bonds trail corporate bonds, which have averaged about 5.8 percent since 1925, and high-yield (junk) bonds that tend to offer yields of 2 to 4 points higher than the AAA-rated corporate bonds. The 5.3 percent average annual return earned by T-bonds is about half the return from blue chip stocks, which have averaged 10.7 percent per year.
However, because of their tax-favored status ( T-bonds and notes are exempt from state and local taxes), the relative return they offer would be slightly higher than 5.3 percent. The bonds of choice for real tax savings are municipal bonds which are exempt from federal taxes - and, in some cases, state taxes, as well. But the average annual return from municipal bonds has been a paltry 4.2 percent.
Returns for T-bonds and notes can vary greatly from year to year. The yields hit double-digits in the early 1980s -as high as 14 percent - but dropped to less than 5 percent in 2003. T-bonds have provided a significantly higher yield than T-notes. In 2003, while T-bonds were paying about 4.9 percent, 10-year notes were paying only about 3.9 percent. The shorter the maturity, the lower the yield. Seven-year notes were paying 3.44 percent, 5-year notes were at 2.85 percent, 3-year notes were at 1.87 percent, and 2-year notes were at just 1.56 percent.
Interest rates are determined based on bids from bond buyers at regular auctions held by the U.S. Treasury. Bond rates have tracked fairly closely with the "prime rate," which is a benchmark loan rate banks charge to their best commercial customers.
There are almost no risks associated with owning Treasury bonds and notes. Like all government-issued debt instruments, they are almost as safe as cash itself because they are backed by the full faith and credit of the federal government.
