Key concepts and practical strategies to know when investing in U.S. bonds

In the current uncertain economic environment, many investors are seeking stable assets. Among these, U.S. Treasury bonds are considered one of the most reliable investment instruments in the global financial markets. Despite relatively low nominal interest rates, U.S. Treasury bonds offer excellent liquidity and stability, providing both individual and institutional investors with steady returns and principal protection. This article will comprehensively cover the basic concepts of U.S. bond investing, specific purchasing methods, potential risks, and portfolio strategies tailored for Korean investors.

Fundamentals of Bond Investing: What Is a Bond?

A bond is a financial contract between the issuer and the investor, where the investor lends funds in exchange for periodic interest income and repayment of principal at maturity. The government issues treasury bonds to fund national operations, paying interest to bondholders in return.

The most actively traded product in the modern bond market is the U.S. 10-year Treasury note. It serves not only as an investment vehicle but also as a barometer of global economic confidence. In the bond liquidity market, the 10-year note is primarily traded for speculative purposes rather than for holding.

Types of U.S. Bonds and Interest Rate Mechanisms

U.S. government-issued bonds are classified into three categories based on maturity:

T-bill(Short-term Treasury): Maturities under 1 year, with minimal risk and very high liquidity.

T-note(Medium-term Treasury): Maturities from 1 to 10 years, suitable for stable income generation.

T-Bond(Long-term Treasury): Maturities over 10 to 30 years, offering fixed interest rates ideal for long-term asset management.

During economic downturns, these various bonds become key components of diversified investment portfolios. U.S. Treasury bond yields serve as benchmarks for risk-free interest rates in the global financial market, with the 10-year Treasury yield reflecting macroeconomic stability worldwide.

Relationship Between Bond Prices and Yields

Bond yield( is expressed as the expected total return divided by the purchase price, known as the yield). The trading price of bonds in the market fluctuates from the original issue price, driven by real-time supply and demand.

When demand for bonds increases, prices rise and yields fall. Conversely, when demand decreases, prices fall and yields rise. Therefore, bond prices and yields move inversely, reflecting market sentiment.

Longer maturities entail higher future uncertainty, so long-term bond yields should normally be higher than short-term yields. However, during recessions, a flight to safety can cause long-term bond demand to surge, leading to lower long-term yields than short-term yields—a phenomenon known as the inverted yield curve(.

Four Key Advantages of Investing in U.S. Bonds

) 1. Top-tier Safety

Since the U.S. government guarantees repayment, U.S. bonds are regarded as the safest investment assets. Even during global economic crises or recessions, many investors flock to U.S. bonds due to their near-zero default risk.

2. Predictable Regular Income

U.S. bonds offer fixed interest rates established at issuance, typically paying interest semiannually. They are ideal for retirees or conservative investors seeking stable income.

3. Excellent Market Liquidity

U.S. bonds are traded in a highly liquid market, allowing quick sale if needed. Investors can hold bonds until maturity or sell them at any time, providing flexibility for portfolio adjustments.

4. Tax Benefits

Interest income from U.S. bonds is subject to federal income tax but exempt from state and local taxes. This enhances after-tax net returns.

Four Major Risks of Investing in U.S. Bonds

1. Interest Rate Risk

If market interest rates rise after bond purchase, new bonds are issued at higher rates, making existing bonds less attractive and decreasing their market value. Selling bonds before maturity in a rising rate environment may result in losses.

( 2. Inflation Risk

Fixed-rate bonds may not keep pace with inflation. If inflation exceeds the bond’s yield, real returns diminish. While inflation-linked bonds)TIPS( are designed to mitigate this risk, regular bonds are not.

) 3. Currency Risk

For foreign investors, exchange rate fluctuations are significant. Purchasing U.S. bonds in currencies other than USD exposes investors to currency risk, where a weakening dollar reduces the value of interest and principal when converted back to their home currency.

4. Credit Risk

Theoretically, there is a possibility that the U.S. government might default. Although the U.S. is considered the most creditworthy issuer and has a long history of fulfilling debt obligations, political or economic crises could pose a default risk. However, given the high credit rating, this risk is extremely low.

How to Purchase U.S. Bonds: Tailored for Investors

U.S. bond investment methods can be chosen based on individual goals, risk tolerance, and operational preferences.

Method 1: Direct Bond Purchase

Individual investors can buy U.S. government bonds directly via the TreasuryDirect website or through brokerage firms in the secondary market.

Advantages:

• Full control over ownership and trading decisions
• No management fees unlike mutual funds or ETFs
• Guaranteed interest payments and full principal repayment at maturity

Disadvantages:

• TreasuryDirect purchase limit of $10,000 per transaction
• Need significant capital and management effort for diversified portfolios
• Early sale before maturity may require selling at a discount in a rising rate environment

Suitable for: Conservative investors seeking predictable income and willing to hold until maturity, retirees needing stable cash flow

( Method 2: Bond Funds

Managed by professional fund managers, bond funds pool capital from multiple investors to operate diversified bond portfolios.

Advantages:

• Exposure to a broad range of bonds reduces individual bond risk
• Active management adapts to market conditions
• Low initial investment required for diversification

Disadvantages:

• Management fees reduce overall returns
• No direct control over individual bonds within the fund

Suitable for: Investors seeking professional management, diversification, and long-term stable returns

) Method 3: Bond Index Funds###ETFs###

Exchange-traded funds that track specific bond indices, following a passive management approach.

Advantages:

• Much lower operating costs compared to active funds
• Traded on stock exchanges, offering high liquidity and flexibility
• Transparent index tracking with predictable performance

Disadvantages:

• Price volatility influenced by stock market fluctuations
• Slight tracking errors due to management fees and trading costs
• No active management to respond to market changes

Suitable for: Investors wanting low-cost exposure to U.S. bonds or preferring direct investment over fund managers

Strategic Portfolio Construction: Korea and U.S. Bonds

Diversifying investments between Korean and U.S. bonds can build a more resilient portfolio.

Key Benefits of Diversification

Regional and Currency Diversification: Holding bonds from two different countries reduces exposure to country-specific risks such as economic downturns, political instability, or interest rate changes.

Currency Hedging Effect: Holding bonds denominated in both KRW and USD can partially offset exchange rate risks. When the KRW weakens, USD-denominated assets may appreciate in local currency terms.

Asynchronous Economic Cycles: Korea and the U.S. often experience different economic cycles, so downturns in one may be offset by growth in the other.

Practical Investment Strategies for Korean Investors

1. Selective Currency Hedging Strategy

The main concern for Korean investors is currency risk. Using derivatives like forward contracts can limit exchange rate fluctuations. However, hedging also caps potential gains from favorable currency movements.

A balanced approach is to hedge part of the investment capital while leaving the rest unhedged, maintaining some exposure to currency appreciation.

2. Duration Matching Strategy

Duration measures a bond’s sensitivity to interest rate changes, representing the average time until cash flows are received.

For long-term principal preservation, a portfolio composed of long-term U.S. bonds offers stability and predictable income. During periods of high interest rate volatility, incorporating shorter-duration bonds can reduce overall portfolio volatility.

3. Tax Optimization Management

Interest income from U.S. bonds is taxed at the federal level but benefits from the U.S.-Korea Double Taxation Agreement###DTA(, preventing double taxation. Investors should consult tax professionals to understand the tax implications in both countries.

) Portfolio Case Study

Consider a balanced portfolio with 50% Korean bonds and 50% U.S. bonds. This structure aims to achieve both principal safety and income generation.

Diversifying across countries reduces dependence on a single economy, lowering overall risk. The portfolio’s value in KRW terms fluctuates with exchange rates.

For example, if 50% of U.S. bonds are hedged against currency risk:

• When USD is strong: unhedged portion yields higher returns in KRW
• When USD is weak: hedged portion offsets losses, stabilizing returns

Conclusion: A Wise Approach to U.S. Bond Investment

U.S. bonds offer stable and predictable investment opportunities for both individual and institutional investors. Success depends on understanding and managing risks such as interest rate fluctuations, inflation, and currency movements.

For Korean investors, combining U.S. bonds with domestic bonds through strategic portfolio diversification can enhance income stability and risk mitigation. Choosing among direct purchase, bond funds, or ETFs should align with individual investment goals and risk appetite. Each method has its own advantages and disadvantages; clarity on objectives and risk tolerance is essential before making a selection.