Government securities refer to a variety of investment vehicles issued by a government. You may be familiar with treasury bills, bonds or notes, but you may not be aware that other countries issue debt to investors as well. Read on to learn more about what government securities are and the different types that exist.
What Are Government Securities?
Government securities are debt instruments sold to fund an independent government’s operations. Government securities work in a similar fashion to corporate bonds. Corporate bonds help firms afford equipment, operational expenses and other expenses that may help them grow or boost profits. With government securities, the funds are often used for military projects, special infrastructure construction and necessary operating costs. By using this form of funding, governments can avoid increasing taxes or issuing spending cuts.
Once the government issues a security, individual or institutional investors can buy them. An individual should buy a security with the intention of holding onto it until the maturity date. It’s also profitable to sell them before their maturity date on a secondary market.
Investors often buy government securities to either benefit from the cash flow of the coupon payment or to add a conservative, risk-free investment to their diversified portfolio. Government securities are often risk-free because their funding is through the American government. Government securities in other nations may have a higher chance default. If the country is facing collapse or instability, the investor may risk default of the security.
Since American government securities are risk-free, this investment vehicle often has a low-interest rate compared to those of corporate bonds. Therefore, government securities can pay a lower rate even in a healthy economic landscape or when interest rates are on the rise. These low-interest rates may not keep pace with inflation.
Treasury bills or T-bills are short-term securities. This means they come with shorter maturity dates than bonds and notes. T-bills are often sold in terms ranging from a few days to 52 weeks.
These government securities have a face value, such as $1,000, $5,000 or $10,000. You can usually buy them for a reduced rate. The amount you pay is the discount rate. Once the T-bill matures, the government pays the entire amount of the bill.
Another form of the treasury bill is the cash management bill. This type of treasury bill is usually issued with a variety of terms. These terms only last a few days. The cash flow from this type of government security is often used to pay for shortfalls or emergency government funding.
You can buy treasury notes or T-notes in terms of two, three, five, seven or 10 years. They pay interest every six months until they reach their maturity date. Once a treasury note reaches maturity, individuals can redeem the entire face value.
You can buy a treasury note at a discount, at a premium or at face value depending on the current market. Like with many government securities, you can bid on a treasury note in one of two ways. The first way is to use a noncompetitive bid. This method requires you to agree to accept the interest rate the auction determines.
The second option is to use a competitive bid. If you choose to go the route of a competitive bid, you must first specify the number of T-notes you wish to purchase and the amount of return you want to receive on your investment. With this method, you establish the discount you want to receive on your initial purchase. The Treasury has the option to accept or reject your competitive bid. This type of bidding structure is also used to sell treasury bonds, Treasury Inflation-Protected Securities (TIPS) and other types of government securities.
Treasury bonds or T-bonds have 30-year terms and pay interest every six months. Once the bond matures, you’ll receive the entire face value of the security. If you want to buy a treasury bond, you’ll need at least $100 to purchase a security directly from the U.S. Treasury, or from a broker or banker. You can either let the treasury bond reach maturity or sell it before the maturity date on a secondary market.
Treasury Inflation-Protected Securities (TIPS)
Treasury Inflation-Protected Securities (TIPS) are available for five-, 10- or 30-year terms. Like conventional treasury bonds, you’ll receive interest payments every six months. TIPS are very similar to conventional Treasury bonds, but there’s one essential difference. A standard treasury bond keeps the same principal during the entire term of the bond. However, the par value of a TIPS will increase to keep pace with the Consumer Price Index (CPI). This keeps the principle of the bond on track with inflation.
If inflation increases during the year, the security will increase in value during that year. Instead of having a bond that’s worthless once it matures, you have a bond that maintains its value throughout its life.
Floating Rate Notes (FRN)
A floating rate note (FRN) issues for a term of two years. It’s a government debt instrument with an interest rate that changes based on an external benchmark. This benchmark is usually equal to the money market reference rate. You can compare these benchmarks to the federal fund rate or London Inter-bank Offered Rate (LIBOR). With an American FRN, the interest payments rise and fall depending on the discount rate.
Each FRN has what’s called a “reset period.” This is how often the interest rate resets based on the benchmark. Reset periods vary. Some FRNs may reset their interest rates daily or weekly. Others may do so only quarterly or on an annual basis.
Savings bonds are a low-risk investment product that helps savers combat inflation. These bonds do this by combining a fixed interest rate with inflation. This government security allows the government to borrow money for a set period of time. The borrowing period can be anywhere from one to 30 years. The U.S. Department of Treasury will keep the interest that accrues over the last three months before you withdraw the funds from your bond.
After the five-year mark, you can get your money back at any time. The lowest amount you can contribute to a savings bond is $25 and $50 for paper bonds. The highest amount that you can chip in within a year is $10,000 and $5,000 for paper bonds.
While there are many different types of traditional bonds, you’ll have two options if you want to buy a government bond. The first option is the Series I bond which pays you a fixed interest rate based on inflation. The second option is the Series EE bond that doesn’t account for inflation. Series EE bonds make sure that after 20 years your original bond investment doubles. In other words, if you buy Series EE bonds at half the value, the Treasury guarantees that they will reach face value in 20 years. It’s important to note that while the interest rate for a Series I bond won’t change, the interest rate for EE bonds will change because it has a variable interest rate.
How to Buy Government Securities
You can buy government securities in many different ways. A simple and popular way to purchase Treasury securities is through Treasury Direct. Treasury Direct is an online platform that the Treasury Department sponsors. You can also buy government securities though the U.S. Treasury. A final option is to buy them on secondary markets through a financial institution, broker or dealer. You’ll need a minimum of $100 to purchase Treasury bonds, bills, notes, TIPS and FRNs.
If you decide to purchase government securities through TreasuryDirect, you can connect the site to your personal bank account. By using this method, you won’t need to worry about the extra fees and commissions that come with using a broker.
If you’re interested in buying an international government security, you’ll need to work with a broker who has that experience. Often known as a Yankee bond, a foreign government security may be more difficult to invest in. This is because they may come with higher minimum investments, the need for offshore accounts or other specific qualifications.
The Bottom Line
Buying government securities can be a great way to enter the world of investing if you’re not a big risk-taker. When it comes to the investing world, diversifying your portfolio is crucial to your financial security. Ultimately, you’ll have to pick the investment method and strategy that works best for your financial future and your risk tolerance.
Tips for Smart Investing
- To build a well-balance portfolio in line with your goals and risk tolerance, consider working with a financial advisor. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
- Prefer to do it yourself? A good place to start is determining your asset allocation. This is a key element for investors when it comes to balancing the risk of their portfolios. Investors with ample disposable income might choose a riskier asset allocation. Someone nearing retirement age, however, may want to be more conservative. SmartAsset’s asset allocation calculator can help you figure out the allocation that makes the most sense for you.
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