A government bond is a loan you give to a government, and the government pays you back with interest
When you buy a government bond, you are lending money to a federal, state, or local government. The government promises to pay you back the full amount on a specific date, called the maturity date, and to pay you interest along the way. That interest is your return for letting the government use your money.
The most common government bonds in the United States are Treasury bonds, issued by the federal government through the U.S. Department of the Treasury. States and cities also issue bonds to fund schools, roads, and other projects. The basic structure is the same: you give money now, the government pays you back later with interest.
Government bonds are considered very safe investments because governments have the power to collect taxes and are unlikely to default. That safety comes with a trade-off — the interest rate on government bonds is usually lower than what you could earn from riskier investments like stocks.
Key Takeaways
- A government bond is a debt instrument where you lend money to a government and receive interest payments in return.
- Treasury bonds are issued by the federal government and are backed by the full faith and credit of the United States.
- Bonds have a maturity date when the government repays the full amount, and they pay interest either regularly or at maturity.
- Government bonds are considered low-risk investments, which is why they pay lower interest rates than stocks or corporate bonds.
- You can buy bonds directly from the Treasury or through a bank or brokerage firm.
How the interest payments work
Government bonds pay interest in different ways depending on the type. Coupon bonds pay you interest at regular intervals — often twice a year — while you hold the bond. When the bond reaches maturity, you get the final interest payment plus your original investment back.
Zero-coupon bonds work differently. You buy them at a discount to their face value — meaning you pay less than the amount printed on the bond. When the bond matures, the government pays you the full face value. The difference between what you paid and what you receive is your return.
The interest rate on a government bond is set when the bond is issued and does not change. If interest rates in the economy rise after you buy the bond, your bond becomes less attractive to other buyers because it pays a lower rate. If rates fall, your bond becomes more valuable.
The different types of Treasury bonds
The U.S. Treasury issues bonds with different maturity dates, and the names tell you how long until you get your money back. Treasury bills mature in one year or less. Treasury notes mature in two to ten years. Treasury bonds (the formal name for the longest-term version) mature in 20 or 30 years.
Shorter-term bonds pay lower interest rates because you are lending the money for a shorter time. Longer-term bonds pay higher rates because the government is borrowing your money for longer and there is more risk that inflation will eat into your returns over decades.
State and local governments issue municipal bonds, which work the same way but often have a tax advantage — the interest you earn may not be subject to federal income tax, and sometimes not state or local tax either if you live in the state that issued the bond.
Why people buy government bonds
People buy government bonds for safety and predictability. Unlike stocks, which can lose value, a government bond will return your full investment at maturity as long as the government does not default — which is extremely rare for the U.S. Treasury. You know exactly how much interest you will earn and when you will receive it.
Bonds are also useful for spreading risk. A portfolio that holds both stocks and bonds is less volatile than one holding only stocks, because bonds tend to hold their value even when stock prices fall. Many people use bonds as a way to preserve wealth they cannot afford to lose.
Retirees and people nearing retirement often hold bonds because they need steady income and cannot afford to wait out a stock market downturn. The predictable interest payments from bonds can cover living expenses without forcing someone to sell stocks at a bad time.
How to buy government bonds
You can buy Treasury bonds directly from the U.S. Department of the Treasury through a website called TreasuryDirect. You set up an account, choose which type of bond you want, and the Treasury deducts the money from your bank account. There are no fees, and you can buy bonds in amounts as small as $100.
You can also buy bonds through a bank or brokerage firm, though you will usually pay a small fee for this service. Banks and brokerages also let you buy bonds that have already been issued and are trading on the secondary market — meaning you are buying from another investor rather than directly from the government.
Municipal bonds are typically bought through a broker or financial advisor because they are not sold directly to the public the way Treasury bonds are. Your broker can help you find bonds issued by the state or city you are interested in.
What happens to your bond before maturity
You do not have to hold a bond until it matures. You can sell it to another investor at any time on the secondary market. However, the price you receive depends on current interest rates and how much time remains until maturity.
If interest rates have risen since you bought the bond, buyers will pay less for your bond because they can get a higher rate on new bonds. If interest rates have fallen, your bond becomes more valuable because it pays a higher rate than new bonds. This is why bond prices and interest rates move in opposite directions.
If you need your money before maturity and interest rates have risen, you will receive less than you paid. This is the main risk of buying longer-term bonds — you are locked into a lower interest rate if the market moves against you.
The relationship between bonds and inflation
Inflation erodes the purchasing power of the money a bond pays back to you. If you buy a bond paying 3 percent interest but inflation rises to 4 percent, your real return — what your money can actually buy — is negative.
The Treasury offers Treasury Inflation-Protected Securities (TIPS) to address this problem. The principal amount of a TIPS bond adjusts with inflation, so your payment at maturity keeps pace with rising prices. TIPS pay lower interest rates than regular Treasury bonds because the inflation protection has value.
For bonds issued by states and cities, there is no inflation protection built in. You receive the same dollar amount regardless of inflation, so your purchasing power declines if prices rise significantly over the life of the bond.
Frequently Asked Questions
Is my money safe if I buy a government bond?
U.S. Treasury bonds are backed by the federal government's ability to collect taxes and are considered the safest investment available. The risk of default is extremely low. State and local bonds are also generally safe, though slightly riskier than Treasury bonds because local governments have less revenue than the federal government.
Can I lose money on a government bond?
If you hold the bond to maturity, you will receive your full investment back. If you sell before maturity and interest rates have risen, you will receive less than you paid. You can also lose purchasing power to inflation if the interest rate on the bond is lower than inflation.
How much interest will I earn on a government bond?
Interest rates vary based on the type of bond, how long until maturity, and current market conditions. Treasury bills currently pay different rates than Treasury notes or bonds. You can see current rates on the TreasuryDirect website before you buy.
What is the difference between a bond and a stock?
When you buy a stock, you own a small piece of a company and share in its profits. When you buy a bond, you are lending money and receiving interest. Stocks can gain or lose value based on company performance; bonds return a fixed amount at maturity.
Can I buy bonds for my child or grandchild?
Yes. You can buy Series EE savings bonds or Series I savings bonds through TreasuryDirect as gifts. These bonds are designed for long-term saving and have tax advantages if used for education expenses. You can also buy regular Treasury bonds in a custodial account for a minor.