Complete Guide to U.S. Bond Investment: Easy-to-Understand Interest Rates and Yields for Beginners

Why U.S. Bonds? The Real Reasons Investors Overlook

When the economy is uncertain, investors look for something. That is U.S. bonds. Since the U.S. government guarantees repayment, they are considered virtually risk-free assets. The nominal interest rate may be low, but liquidity and regular interest payments that can be cashed out at any time are attractive.

Especially for Korean investors, this is an asset they should pay more attention to. Because U.S. bonds can serve as a hedging tool by utilizing exchange rate fluctuations between the Korean won and the dollar.

The Basics of Bonds: Know Them Precisely Before Investing

Bonds may seem complicated, but the principle is simple. The government borrows money from individuals or institutions to raise necessary funds. In return, it promises to return the principal on a specified date and pay interest regularly, usually every 6 months.

U.S. Treasury securities are divided into three types based on maturity:

• T-bill: Short-term bonds under 1 year, safest and most liquid
• T-note: Medium-term bonds from 1 to 10 years, the most actively traded
• T-Bond: Long-term bonds from 10 to 30 years, offering higher fixed interest rates

The yield on the 10-year U.S. Treasury note plays a crucial role as an indicator in the international financial markets. Its fluctuations help gauge the overall economic situation worldwide.

What Does It Mean When Interest Rates and Yields Move Oppositely?

This is a confusing point for many novice investors. Interest rates and yields are different.

After purchasing a bond, if market conditions change, the bond’s price also changes. When demand for safe assets like bonds increases, prices go up and yields go down. Conversely, if demand decreases, prices fall and yields rise.

In other words, bond prices and yields move in opposite directions, reflecting investor sentiment. When the economy is unstable, demand for long-term bonds surges, causing yields to fall, while short-term yields remain relatively high. This often signals an impending recession.

Four Key Attractions of U.S. Bond Investment

( 1. Government Guarantee and Safety The U.S. government directly guarantees repayment. This is why investors flock to U.S. bonds during economic downturns.

) 2. Predictable Regular Income Interest rates are fixed at issuance and paid regularly every 6 months. Ideal for retirees needing stable cash flow.

3. High Liquidity

U.S. bonds are the most actively traded in the bond market. You can sell them anytime without waiting until maturity, making it easy to respond to urgent funding needs.

4. Tax Advantages

Federal taxes are levied, but state and local taxes are exempt. This results in a higher after-tax return.

Four Risks Investors Often Overlook

1. The Trap of Rising Interest Rates

When interest rates rise, newly issued bonds offer higher yields. The value of existing low-yield bonds drops. Selling before maturity during such times can lead to losses.

2. Inflation Erodes Returns

Bonds pay fixed interest, which may not keep pace with rising prices. If inflation exceeds bond yields, real returns can turn negative. TIPS (Treasury Inflation-Protected Securities) can offset this, but regular bonds do not.

( 3. Exchange Rate Fluctuations )Especially Important for Korean Investors( When the dollar weakens, the value of interest and principal in won decreases. Conversely, a strong dollar amplifies returns.

) 4. Credit Risk ###Very Low in Reality### Theoretically, the U.S. government could default. However, as the world’s highest credit-rated issuer, the actual risk is extremely low.

How to Buy U.S. Bonds: Three Options

( 1. Direct Purchase Buy directly from the U.S. government via TreasuryDirect or through securities firms in the secondary market.

Advantages:

• No management fees
• Full control over your portfolio
• Holding to maturity guarantees full principal and interest

Disadvantages:

• Limit of up to $10,000 per purchase
• Need to buy multiple bonds for diversification, requiring significant capital
• Potential loss if interest rates rise before selling

Suitable for: Conservative investors who can hold long-term and want regular income, retirees

) 2. Bond Funds ###Mutual Funds( Managed by professional fund managers pooling various U.S. bonds.

Advantages:

• Diversification reduces risk
• Active management based on market conditions
• Can build a diversified portfolio with small amounts

Disadvantages:

• Management fees reduce returns
• No direct control over individual bonds
• Performance depends on fund manager

Suitable for: Investors seeking professional management but avoiding direct management, conservative investors wanting diversification

) 3. Bond ETFs ###Exchange-Traded Funds( Passive funds tracking specific U.S. bond indices. Traded on stock exchanges like stocks.

Advantages:

• Lower management fees )Cheaper than active funds###
• Flexible trading like stocks, high liquidity
• Transparent index tracking

Disadvantages:

• Exposure to market volatility ###Prices can fluctuate even if bonds are stable(
• Tracking error possible
• Cannot actively respond to market changes due to passive nature

Suitable for: Investors wanting minimal fees, preferring direct investment, trusting index returns

Smart Investment Strategies for Korean Investors

) 1. Currency Hedging to Manage FX Risk Exchange rate fluctuations affect returns when converting dollars to won. One approach is to hedge part of the investment with forward contracts and keep the rest unhedged.

For example, with a 50% hedging strategy:

• When the dollar is strong: unhedged portion yields extra profit
• When the dollar is weak: hedged portion offsets losses

2. Duration Matching to Achieve Goals

Duration measures a bond’s sensitivity to interest rate changes. For long-term holding, focus on long-term bonds; for short-term gains, include short-term bonds to balance your portfolio.

( 3. Tax Optimization U.S. interest income is subject to federal tax but may also be taxed in Korea. Fortunately, the U.S.-Korea DTA (Double Taxation Agreement) prevents double taxation. Consulting a tax professional is wise.

Practical Portfolio Example

Imagine a balanced portfolio with 50% Korean government bonds and 50% U.S. bonds.

Returns:

• Diversification across regions reduces country-specific risks
• Currency diversification hedges won-dollar exchange rate fluctuations

Exchange Rate Strategy:

• Hedge 50% of U.S. bonds, keep 50% unhedged
• During dollar strength: unhedged portion yields excess returns
• During dollar weakness: hedged portion provides loss protection

Final Thoughts: Choose the Strategy That Fits You

U.S. bonds are a proven investment for both individual and institutional investors. However, to generate stable returns, you must understand interest rate, inflation, and exchange rate risks accurately.

Korean investors should pay particular attention to currency management. Holding both U.S. bonds and Korean government bonds can diversify your portfolio and provide currency hedging benefits.

Decide whether to buy directly, through funds, or ETFs based on your capital, time, and risk appetite. No need to rush. Prepare systematically and build long-term wealth with trusted assets like U.S. bonds.