Treasury notes, or T-notes, are issued in terms of two, three, five, seven and 10 years and pay interest every six months until they mature. The price of a note may be greater than, less than or equal to the face value of the note, depending on demand. If demand by investors is high, the notes will trade at a premium, which effectively reduces investor return. Upon maturity, investors are paid its face value.
Treasury bonds are issued with 30-year maturities and pay interest every six months. They are sold at auction four times a year: in February, May, August and November. The price and yield are determined at auction. Upon maturity, you are paid face value plus interest.
All three types of Treasury securities are offered in increments of $100.
Risks: Treasury securities are considered virtually risk-free because they are backed by the full faith and credit of the U.S. government. You can count on getting interest and your principal back at maturity. However, the value of securities fluctuates, depending on whether interest rates are up or down. In a rising rate environment, existing bonds lose their allure because investors can get a higher return from newly issued bonds. Therefore, if you try to sell your bond before maturity, you may experience a capital loss.
Treasuries also are subject to inflation pressures. If the interest rate of the security is not as high as inflation, investors lose purchasing power.
Because they mature quickly, the risk of holding T-bills is not as great as with longer-term T-notes or Treasury bonds.
Liquidity: All Treasury securities are very liquid, but if you sell prior to maturity you may experience gains or losses, depending on the interest rate environment (see risks, above).
Pros and cons: Treasury securities are considered an affordable, safe investment for the average investor. Low return on your investment -- in exchange for lower risk -- is the main downside to Treasuries. T-notes and T-bonds pay interest every six months, which is fine if you don't need the income more regularly. Interest income from all three types of treasuries is subject to federal income tax but exempt from local and state income taxes.
Where to find them: They can be bought and sold via the TreasuryDirect program or through your broker or financial institution.
Caveats: The Treasury Department reduced the minimum purchase from $1,000 to $100, effective April 7, 2008, to encourage more people to save and invest. Currently, the high demand for short-term Treasuries is stifling yields.
Words of caution: "Treasuries are more suited to investors who are closer to retirement or closer to tapping that nest egg as opposed to the early years, when they're focused on accumulating that nest egg. I don't find Treasuries particularly appealing right now because the yields remain quite low, especially on shorter maturities. High-yielding CDs are a much better alternative for short time horizons. And longer maturity Treasuries are no deal either, considering future prospects for inflation. The 10-year Treasury right now is paying about 3.7 percent. But if you're going to put your money to work for 10 years, put it in a 10-year TIPS (Treasury Inflation-Protected Security), where you're going to get a return that's pegged to inflation." -- Greg McBride, CFA, senior financial analyst, Bankrate.com.