Long Term vs. Short Term Treasury Bonds

Both long- and short-term Treasury securities can be a secure source of income.

Both long- and short-term Treasury securities can be a secure source of income.

Treasury bonds are interest-bearing investments issued and guaranteed by the U.S. government. Treasury bonds that mature in 10 years or more are typically considered long-term bonds. Shorter-term Treasury securities maturing in two to 10 years are more accurately referred to as Treasury notes. While both short- and long-term Treasury securities share certain characteristics, particularly regarding credit quality, they have different degrees of investment risk.

Credit Risk

All Treasury securities, regardless of duration, are backed by the "full faith and credit" of the U.S. Government. This amounts to a government guarantee that you will receive both your promised interest payments and the return of your principal if you hold the bonds until maturity. Since the U.S. government has the authority to print money, the risk of the government not honoring its obligations is small. Corporate bonds, which carry more credit risk, are priced relative to Treasuries, which are considered to be "riskless" assets in the industry. Whether you buy a two-year or a 30-year Treasury security, you have the same negligible risk of default.

Income

If you are investing primarily to earn income, long-term Treasury bonds will typically have the edge over shorter-term securities. Except in unusual circumstances, the longer the maturity of your bond, the higher the interest rate you will earn. For example, as of July 27, 2012, a two-year Treasury note paid 0.25 percent in interest, while a 30-year bond paid 2.63 percent.

Interest Rate Risk

When market interest rates rise, the price of existing bonds falls. The longer the maturity of a bond, the greater the price will drop in response to rising rates. This phenomenon is known as interest rate risk and is one of the major risks attached to investing in any type of bond. A longer-term Treasury bond will have more interest rate risk than a shorter-term Treasury security. However, as an investor you can overcome interest rate risk by holding the investment until maturity. At maturity, a Treasury security will pay back "par value," or typically $1,000 per bond, regardless of current market interest rates. Interest rate risk is only a danger if you sell your bond before maturity.

Price

If you buy a bond directly from the government, you'll usually pay the par value of $1,000 per bond. If you buy a bond from a broker in the secondary market, the price will vary depending on the movements of interest rates. Since interest rates on bonds have been falling since 1981, prices for bonds issued in previous years have generally risen. Longer-term bonds often have higher prices in the secondary market than short-term Treasury securities because longer-term bonds typically carry higher interest rates.

 

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