How to Buy Treasury Bonds

Normally, the Treasury sells bonds at auction four times a year. The dates and the total value of the bonds issued are announced in major newspapers and financial publications.

A bond sale is actually two simultaneous auctions, with primary dealers as the main bidders. Primary dealers are large, institutional investors that trade directly with the Treasury. Before the auction, they submit competitive bids, which state the lowest yield they'll accept. (Yield, you'll recall from economics class, is your return on an investment. It equals the interest the bond earns divided by its purchase price). For example, Cantor Fitzgerald might bid for a $2 billion bond and a yield of 4.15 percent. Bids are taken until the auction starts. At that time, the Treasury uses these bids to set the bonds' yield, and thus the interest rate.

If you're not a large financial institution, you can take part in an auction by placing a noncompetitive bid, which is simply the dollar amount of the bond you want. With a noncompetitive bid, you accept whatever yield and interest rate are established, which you won't know until the auction closes. This transaction is conducted conveniently through the Treasury's online service, TreasuryDirect. During an auction, all noncompetitive bids are filled first. Competitive bids are then doled out until the entire issue has been sold.

But as we said, bond prices change over time. You can sell your bond at any time before it matures to take advantage of this fact. For example, suppose you own a bond that pays 5 percent interest. Newly issued bonds, however, are paying 4 percent interest. Your bond, with its greater return, is comparatively more valuable. You could sell it at a premium, a price higher than its face value that depends on the inflation rate, predicted interest rates and other factors. The buyer also pays you the interest the bond has accrued since the last payment date.

On the other hand, if new issues are returning 6 percent interest, your bond is less valuable. You might decide to sell it at a loss, or a discount, in order to buy a higher-returning bond.

To trade in bonds requires a primary dealer or a broker. To expand beyond bonds to more complex investment packages takes other expert advisers. Invest a few minutes reading the next page for a look at how bond brokers and mutual funds work.

Like restaurants, Treasury bond brokers vary in services offered. Some wait on you hand and foot, others only take and deliver your order. Let's look at the options:

Treasury bonds can be an ingredient in investment buffets called mutual funds, which are actually companies jointly held by a group of investors. A mutual fund's holdings, or portfolio, may consist of stocks, bonds and other investments. They're managed by outside advisers who choose the portfolio's makeup -- you may pay those advisers fees of up to 8.5 percent of the cost of the fund when you buy or sell it.

Compared to Treasury bonds, mutual funds are more accessible and flexible. You can buy an almost unlimited number of shares and sell them at will. The portfolio approach provides security through diversifying (that is, spreading out) your investment: If bond prices are plummeting, stocks might buoy up the fund's return.

Mutual funds fall into three main categories based on the type of investment:

Having stocked you with information, we'll wrap up this discussion on the next page with points to ponder before purchasing a Treasury bond.

Like choosing a career or a life partner, buying a Treasury bond can be a rewarding 30-year relationship. The key is knowing what to expect before signing on the dotted line.

First, weigh the benefits against the costs. When you buy a bond, in exchange for a steady, reliable return you accept relatively low interest rates. That means you need to invest a larger sum in bonds than in stocks or other Treasuries in order to make the same return. Also, while the interest pays every six months, you won't see your initial investment money for up to 30 years, assuming you keep the bond to maturity. That could be a problem if you need it before then.

On the other hand, bonds require less maintenance than stocks or a mutual fund. Barring some drastic swing in interest rates, you can feel comfortable holding onto your investment, reaping its returns until it matures. And since many brokers charge a fee per transaction, that can save money in the long run.

If you're willing to accept the conditions, take time to compare brokers. Decide what features are most important. Are you a confident investor who only needs an authorized agent to make trades? Or do you want the reassurance of being able to phone, e-mail or text an individual broker with questions and concerns? Either way, you'll want a competent broker who understands your financial goals and will help manage your investments to meet them. Ask for references to see how experienced he or she is with clients of your means and situation. And, although most brokers operate ethically, it can't hurt to run background checks on your candidates through the Securities and Exchange Commission's Investment Adviser Public Disclosure Web site.

Making money is the point of this whole venture, so learn how -- and how much -- brokers charge for their services. Besides transaction fees, they may charge a commission or flat fee based on the size of the bond. Also, brokers typically charge a markup when they sell you a bond, the amount of which they don't have to disclose. Again, ask. A markup of 1 to 2 percent of the bond's price is considered fair.

We hope this primer sets you on the path to years (at least 30) of happy investing. As guidance on using your riches, we suggest this quote from novelist Miguel de Cervantes, who set many of his characters on similarly long-term quests: "The gratification of wealth is not found in mere possession or lavish expenditure, but in its wise application" [source: Forbes].