Deep Dive: Here’s how easy it is to buy U.S. Treasury bonds without fees or commissions

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Investors are pouring money into U.S. bonds because of negative interest rates around the world and fears the new coronavirus will damage the economy and companies.

For example, the share price of the Vanguard Extended Duration Treasury ETF EDV, +3.03% is up 19% this year. The exchange traded fund’s average effective maturity is 25.1 years, which means it has a relatively high yield of 2.13%. But it’s especially sensitive to the direction of interest rates.

Investors who are looking for the least amount of risk can avoid fluctuating share prices by purchasing their own Treasury securities with no fees or commissions. See more on that below.

U.S. rates could fall further

In a world with about $14 trillion in negatively yielding debt, U.S. Treasury yields are relatively high, even though the yield on 10-year Treasury notes TMUBMUSD10Y, 0.745% keeps hitting all-time lows. On Thursday the yield fell to 0.93% from 1.92% at the end of December.

Here’s a chart showing price action over the past year for EDV:

Investors outside the U.S. looking for safety and any sort of yield may continue to buy so much U.S. debt that interest rates drop even lower. It is even possible, if the coronavirus outbreak doesn’t subside soon, or if economic figures show a severe decline in the GDP growth rate, the Federal Reserve may follow most other developed countries into the negative for short-term interest rates. The Fed, in a surprise move, reduced its benchmark rate by 50 basis points March 3. TMUBMUSD10Y, 0.745%

Why buy your own?

The Vanguard Extended Duration Treasury ETF’s yield of 2.13% is attractive — especially if you are looking to invest in debt securities with very low credit risk and believe interest rates are likely to remain low, or head even lower.

Like any exchange traded fund, or mutual fund, EDF has a fluctuating share price. It moves in line with bond-market demand and interest rates, following the inverse relationship between the two: If interest rates fall, the price of bonds increases, so buyers will be receiving the prevailing yields, all things being equal — which they are when you are dealing with one issuer with a high credit rating.

If you go for higher yields with corporate bonds or stocks, you face additional credit risk and various operational risks to issuers’ businesses.

But what about that price fluctuation? If you buy a shorter-term bond fund, it will be less sensitive to the movement of interest-rates — its share price will be less volatile. For example, the iShares 7-10 Year Treasury Bond ETF IEF, +0.88% has an SEC yield of 1.22%, net of annual expenses of 0.15% and a four-star rating from Morningstar. Its share price has risen 14% over the past year and 7% this year. Moving further down, the iShares 3-7 Year Treasury Bond ETF IEI, +0.41% has an SEC yield of 1.12%, with expenses of 0.15% and also a four-star Morningstar rating. IEI’s share price has increased 5% over the past year and 4% during 2020.

If you believe interest rates are headed even lower, a Treasury bond fund or ETF may still be an excellent investment for you.

But what if you want to escape fluctuating prices entirely? Buying your own newly issued Treasury securities may be the safest way to preserve a significant amount of capital while earning a decent yield, at least for now, unless you can park all your cash in banks while making sure all the money is covered by FDIC insurance and being satisfied with the yields.

If you buy individual bonds, you no longer have a fund calculating a net asset value (that day’s closing market value for a fund’s investments divided by the number of outstanding shares), or looking at an ETF’s share price ,which may have its own discount or premium to the NAV. You can hold your individual bond to maturity without worrying about market fluctuation.

And that’s the rub — can you really hold until maturity? Assuming you can, with a portion of your portfolio, you will never have to worry about market-price fluctuation. But you will have to think about the price you pay at the initial purchase.

When a bond is issued, it is sold at face value, or par, and its stated interest rate is called the coupon. Once that bond is publicly traded, its market price fluctuates. If the price goes up, the yield (the coupon divided by the price) goes down, and vice versa. If you pay a premium (over par) for a bond and hold it until maturity, you will book a capital loss at maturity, but you will know how much the loss will be before you buy. A bond’s yield to maturity bakes in the premium or discount when you buy.

This can all be simplified if you buy bonds from the U.S. Treasury as they are issued at auction.

How to do it

Here’s the U.S. Treasury’s tentative auction schedule. Auctions for 3-year notes, 10-year notes and 30-year bonds are typically held quarterly, but the current schedule includes auctions for longer-term paper (aside from the 30-year) each month. There are weekly auctions for shorter terms. Here’s a more detailed schedule for this week and next week.

If you have a brokerage account, it is likely that your broker can help you to participate in an auction at no charge. It’s also possible that your broker will charge a nominal fee. Most don’t.

If you don’t have a brokerage account or would rather buy Treasury bonds directly, you need to sign up and create a TreasuryDirect account.

Once you are set up through your broker or TreasuryDirect, you can participate in auctions to buy your own securities. A competitive bid means you specify the interest rate, yield or discount margin (for T-bills) that is acceptable for you. A noncompetitive bid means you are guaranteed to purchase the amount of Treasury paper of the maturity you select at whatever the auctioned interest rate turns out to be.

Treasury notes and bonds pay interest twice a year, based on par and the coupon. Treasury bills are issued at a discount to par, so that the interest is paid at maturity.

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