What Makes Short-Term Bonds Different from Long-Term Bonds?
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What Makes Short-Term Bonds Different from Long-Term Bonds?

What Makes Short-Term Bonds Different from Long-Term Bonds

When you buy a bond, your money goes toward helping the government pay for projects and programs. It also gives you a good return on your money with little risk. Just choose whether you want to buy long-term or short-term Treasury bonds.

Most of the time, the difference between long-term and also short-term Treasury bonds is how long it takes to get your money back. Treasury bonds settle interest every six months, and when the bond is paid off, the face value is given back to the owner.

For short-term Treasury bonds, the date they will be paid off is less than three years from the date they were bought. Medium-term bonds have terms of three to ten years, while long-term bonds have terms of more than ten years.

How to pick the most suitable Treasury bonds

First, decide if you need your money back by a certain date. If you’re investing money you’ll need in a few years; you should probably buy a short-term bond. But you could buy a long-term Treasury bond if you won’t need the money for 10 to 30 years.

The bonds offer an assured return on investment, so people who buy them can plan to use the money for things like a child’s college education or a house.

Is timing the only thing that separates short-term and long-term?

No, is the short answer. The main difference between short-term and long-term bonds is when they mature, but the different lengths of time also lead to other differences. For example, investors in short-term and long-term bonds face different kinds of risk.

Yung-Yu Ma, PhD, chief investment strategist at BMO Wealth Management, says that long-term bonds have more price risk or sensibility to interest rates. Because the money endued in the bond is locked up for a longer time, there is a greater possibility that interest rates will change significantly during the bond term.

Even though there is less price risk with short-term bonds, there is more reinvestment risk. “Short-term bonds mature fairly quickly, and when they do, investors risk losing money if they reinvest the money at the new market rates,” says Ma.

If interest rates are going up at the time, this reinvestment will work out well. But when interest rates go down, it’s not as good for investors to put their money back into the market. When interest rates change, the market price of long-term bonds may change, but investors who keep their bonds until they mature have “locked in a known yield for a longer period, so reinvestment risk is pushed far into the future,” says Ma.

What do long-term and short-term Treasury bonds yield?

One more difference between short-term and long-term Treasury bonds is the return on your investment. Treasury bills or T-bills are other names for short-term Treasury bonds due in less than a year. During the life of the bond, they don’t pay any interest. Instead, they are sold for less than what they are worth. The owner can turn it in for its full face value when the bond comes due. So, when you buy a Treasury bill at a discount, you know exactly how much you’ll earn when it matures: the difference between the face value and the discounted rate you paid for the bill.

Other Treasury bonds pay interest every six months equal to half of their “coupon rate.” For example, let’s say you have a 10-year, $10,000 Treasury note with a 2% coupon rate. The government will send you a payment of $100 every six months. When your note is due, you can get $10,000 for it.

When interest rates are high, these bonds sell for more than their face value. When interest rates are low, they sell for less than their face value. The amount you can expect to get back depends on the interest rate, how long it will be until the bond is paid off, and how much you paid for it.

How to select between long- and short-term investments

The right selection depends on how you feel about risk, what you want to achieve, and how long you have. It’s also smart to think about how interest rates are right now. “When interest rates are going up, short-term bonds tend to do better,” says Bryan Bibbo of The JL Smith Group in Avon, Ohio. “Since the opposite is true when interest rates go down, long-term bonds tend to do better.”

Long-term and short-term bonds can be important parts of a full investment portfolio for many people.

Treasury bonds are one of the secure investments you can make, whether short-term or long-term. Because the full power of the government backs the bonds, there isn’t much chance that you’ll lose the money you put into them.

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Written by Finance Guru

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