U.S. Treasury Bond Investment Guide: A Beginner's Easy-to-Understand Explanation of Yield and Interest Rates

As the global economy becomes increasingly unstable, many investors are paying attention to stable asset allocations. In particular, U.S. Treasury bonds are regarded as a safe haven for the world economy, and despite their low nominal interest rates, they are gaining popularity among domestic investors due to their high liquidity and trustworthiness.

This article will explore everything from the basics of U.S. Treasury bonds to practical investment strategies step by step. It will specifically address concerns Korean investors should have, such as exchange rate risk, taxes, and portfolio construction methods, and will suggest optimal combinations of U.S. and domestic assets.

Starting with the Basic Concept of Bonds

Bonds are essentially IOUs. When governments or corporations need funds, they borrow money from investors and promise to return the principal at a set time. During this process, the borrower pays interest( coupons) to investors, usually semiannually or annually.

U.S. Treasury bonds are issued by the U.S. government and are considered the most stable bonds globally. They are issued to finance government operations, and investors are guaranteed regular interest income and principal repayment at maturity.

The most actively traded product in the bond market is the 10-year bond. This is because bonds are frequently bought and sold for short-term profit rather than long-term holding.

Types and Characteristics of U.S. Treasury Bonds: Varying by Maturity

U.S. Treasury bonds are classified into three types based on maturity.

T-Bills(T-Bill): Maturity within 1 year, with almost no risk and can be liquidated at any time.

T-Notes(T-Note): Maturities from 1 to 10 years, offering moderate yields and stability.

T-Bonds(T-Bond): Maturities from 10 to 30 years, providing fixed interest rates as long-term assets.

During times of economic instability, demand for safe assets like bonds surges. Bond yields serve as benchmarks for the global risk-free rate, with the 10-year U.S. Treasury yield being a key indicator of the global economic outlook.

The Paradoxical Relationship Between Interest Rates and Yields

Yield(Yield) refers to the expected return ratio of a bond’s price. An important point is that bond yields and bond prices move inversely.

When demand for safe assets increases, bond prices rise and yields fall. Conversely, when bond demand decreases, prices fall and yields rise. This mechanism reflects investor sentiment and market expectations in real time.

Additionally, under normal economic conditions, longer maturities entail higher risk, so long-term yields should be higher than short-term yields. However, during economic downturns, demand for long-term bonds can spike, causing yields to fall even as the economy weakens.

Four Practical Advantages of Investing in U.S. Bonds

1. Highest Reliability

Since the U.S. government guarantees repayment, there is virtually no default risk. This is why investors turn to U.S. Treasuries first during economic downturns.

2. Stable Regular Income

Fixed interest rates mean the yield at issuance remains until maturity. Regular interest payments every six months make them ideal for retirees or investors needing steady cash flow.

3. Excellent Liquidity

U.S. bonds are the most traded assets in the bond market. They can be sold at any time before maturity if needed, making portfolio rebalancing easy.

4. Tax Benefits

Interest income from U.S. bonds is subject to federal tax but exempt from state and local taxes. This can result in a higher after-tax yield than the nominal rate suggests.

Four Risks Not to Overlook

( 1. The Trap of Rising Interest Rates

What happens if market interest rates rise after purchasing bonds? Newly issued bonds offering higher yields make existing bonds less attractive. If you sell before maturity, you may have to do so at a loss due to lower prices.

) 2. Inflation Erodes Returns

Fixed-rate bonds cannot keep pace with rising prices. If inflation exceeds the bond’s yield, real returns can become negative. While inflation-linked TIPS exist to hedge against this, regular bonds do not offer such protection.

( 3. Foreign Exchange Volatility

This is especially important for Korean investors. If the won weakens against the dollar, the interest and principal received in dollars, when converted to won, can result in losses.

) 4. Political and Economic Credit Risk

In theory, this exists as the possibility that the U.S. government may default on its debt, but in practice, the probability is extremely low.

How to Buy U.S. Bonds: Three Practical Methods

Method 1. Direct Purchase

You can buy U.S. Treasury bonds directly from the U.S. Treasury via the TreasuryDirect website. In the secondary market, bonds are purchased through securities firms.

Advantages: Owning bonds directly provides high operational autonomy and no management fees. Holding until maturity ensures full receipt of interest and principal.

Disadvantages: Individual investment limits are up to $10,000 per transaction, and significant capital is needed for diversification. Selling before maturity exposes you to interest rate risk and potential losses.

Suitable Investors: Conservative investors willing to hold long-term until maturity, such as retirees or institutions like insurance companies seeking regular income.

Method 2. Bond Funds

Mutual funds managed by professional fund managers that hold a diversified portfolio of bonds.

Advantages: Exposure to various bonds with small capital, benefiting from diversification. Active management tailored to market conditions.

Disadvantages: Management fees reduce net returns. No direct control over individual bonds.

Suitable Investors: Those who find selecting individual bonds cumbersome and trust professional management.

( Method 3. Bond ETFs

Exchange-traded funds that track specific bond indices, traded on stock exchanges like stocks.

Advantages: Lower costs compared to active funds, easy to buy and sell like stocks, high transparency, and predictable index tracking.

Disadvantages: Limited to index tracking; less opportunity for active gains. Price fluctuations due to market volatility.

Suitable Investors: Passive investors seeking market-average returns with low fees.

Global Asset Allocation Strategy for Korean Investors

) Why hold both U.S. and domestic bonds?

Regional Diversification: Economic crises in one country less likely to impact others significantly. The economic cycles of Korea and the U.S. do not always align.

Optimizing Yields: Different interest rate environments allow allocating more to the higher-yielding country.

Currency Hedging: Holding both won and dollars can mitigate the impact of exchange rate fluctuations.

Practical Strategy 1: Selective Currency Hedging

Hedging the entire U.S. bond investment reduces exchange rate risk but may cause missed opportunities during dollar strength. Consider hedging about 50% of the investment via forward contracts, leaving the rest exposed to natural currency movements.

Practical Strategy 2: Duration Management

Duration measures a bond’s sensitivity to interest rate changes. For principal preservation, longer-term U.S. bonds are more stable, but to minimize interest rate volatility, a mix of shorter-term bonds is advisable.

Practical Strategy 3: Tax Optimization

Interest income from U.S. bonds is subject to U.S. federal tax and taxed in Korea as well. Due to the Korea-U.S. Double Taxation Treaty, consulting a tax professional is essential to maximize tax benefits in both countries.

Virtual Portfolio Simulation

Imagine a balanced portfolio composed of 50% Korean bonds and 50% U.S. bonds.

This portfolio is designed to achieve both principal preservation and regular income. It is not solely dependent on the economic risk of one country, thus reducing overall risk.

During periods of dollar strength, unhedged U.S. bonds can provide additional returns when converted to won. Conversely, in a weak dollar phase, hedged portions offset currency losses.

Conclusion: Approach U.S. Bonds Wisely

U.S. Treasury bonds offer stable income opportunities for both individual and institutional investors. However, to succeed, it is crucial to understand interest rate risk, inflation, and exchange rate volatility accurately.

For Korean investors, combining U.S. Treasury bonds with domestic assets can diversify the portfolio and enhance income stability.

The methods to buy U.S. bonds—direct purchase, funds, ETFs—are varied. Choosing the most suitable approach depends on your investment horizon, risk appetite, and capital size.