Complete Guide to U.S. Bond Investing: Understanding Yields and Maximizing Returns

As the financial markets become more volatile, investors seek safe assets. U.S. bonds are the most trusted debt instruments worldwide, backed by government guarantees and high liquidity. They are especially recognized among Korean investors as a core asset for portfolio diversification. This article provides practical investment strategies, from how to buy U.S. bonds to yield management and risk factors.

Understanding Bonds Basics

A bond is a certificate of debt, representing a loan. When investors provide funds, the issuer repays the principal at the maturity date and pays interest periodically(, typically semiannually or annually).

The government operates similarly. When fiscal funds are insufficient for national operations, it issues government bonds to borrow from individuals and institutions, paying a fixed interest rate in return.

The most actively traded product in the government bond market is the U.S. 10-year Treasury note. It is also a highly traded instrument beyond just holding purposes.

Classification and Characteristics of U.S. Bonds

U.S. Treasury bonds are divided into three categories based on maturity:

Short-term bonds(T-bill): Maturities under 1 year, with extremely low risk and immediate liquidity.

Medium-term bonds(T-note): Maturities from 1 to 10 years, offering a balance of reasonable yields and stability.

Long-term bonds(T-Bond): Maturities from 10 to 30 years, providing fixed interest rates suitable for long-term asset management.

During economic downturns, investors tend to increase holdings in these bonds to reduce portfolio volatility. U.S. bond yields serve as benchmarks in global financial markets, with the 10-year yield being a key indicator of global economic health.

The Dynamic Relationship Between Interest Rates and Yields

Yield(yield) refers to the expected profit from purchasing a bond divided by its purchase price. In the secondary market, bond prices fluctuate in real-time based on demand.

When demand for bonds increases, prices rise and yields fall; when demand decreases, prices fall and yields rise. Therefore, bond prices and yields move inversely. Understanding this relationship is the first step in bond investing.

In economic downturns, demand for long-term bonds surges, causing long-term interest rates to fall and short-term rates to rise relatively. This is often interpreted as a sign of recession.

Four Key Benefits of Investing in U.S. Bonds

1. Top Safety

The U.S. government fully guarantees bond repayment. Even during global financial crises, investors shift assets into U.S. bonds, reflecting market perception of minimal default risk.

2. Fixed Return Structure

Fixed interest rates at issuance and regular interest payments ensure predictable cash flows. Ideal for retirees or investors seeking stable income.

3. Excellent Liquidity

U.S. bonds are the most actively traded assets in the bond market. They can be sold at any time before maturity, allowing flexible portfolio adjustments.

4. Tax Benefits

Bond interest is subject to U.S. federal tax but exempt from state( and local taxes), enhancing after-tax returns.

Four Major Risks of U.S. Bond Investment

( 1. Interest Rate Risk

If market interest rates rise after purchase, new bonds are issued at higher rates, making existing bonds less attractive and potentially leading to capital losses if sold early.

) 2. Inflation Risk

Fixed-rate bonds cannot keep pace with rising inflation. If inflation exceeds bond interest rates, real returns can turn negative. Inflation-linked bonds###TIPS### address this risk.

( 3. Currency Risk

For foreign investors, currency fluctuations directly impact returns. A weakening U.S. dollar reduces the value when converted to local currency.

) 4. Credit Risk

Theoretically, the risk that the government defaults on its debt obligations. However, given the U.S. credit rating is at the highest level, actual risk remains extremely low.

Three Methods to Invest in U.S. Bonds

1. Direct Bond Purchase

Advantages:

• Full control over buying and selling decisions
• No management fees like mutual funds or ETFs
• Receive full principal and interest at maturity

Disadvantages:

• Personal purchase limit: up to $10,000 per transaction
• Need to buy multiple bonds for diversification
• Potential losses if sold early during rising interest rate environments

Suitable for: Conservative investors seeking stable long-term income and willing to hold until maturity, such as retirees.

2. Bond Funds###Mutual Funds###

Advantages:

• Exposure to a diversified portfolio of bonds, reducing individual bond risk
• Managed actively by professional fund managers
• Allows diversification with smaller amounts

Disadvantages:

• Management fees reduce net returns
• No direct control over individual bonds

Suitable for: Investors who prefer professional management and want to avoid the hassle of managing individual bonds.

( 3. Bond Index Funds)ETFs###

Advantages:

• Lower operating costs compared to active funds
• Traded on exchanges like stocks, offering high liquidity
• Transparent index tracking

Disadvantages:

• Daily price volatility similar to stocks
• Tracking error may occur
• No active management to adapt to market changes

Suitable for: Investors seeking low-cost, passive investment and trusting market efficiency.

Optimal Strategies for Korean Investors

( The Value of Dual Investment Strategies

Investing simultaneously in Korean and U.S. bonds offers multiple benefits.

Regional Diversification: Exposure to different national economies reduces losses from adverse conditions in a single country.

Currency Diversification: Holding assets in KRW and USD naturally hedges against exchange rate fluctuations. When the dollar strengthens, U.S. bond returns increase; when it weakens, KRW assets maintain relative value.

Offsetting Economic Cycles: Korea and the U.S. do not always experience economic cycles simultaneously, so downturns in one can be offset by growth in the other.

) Maximizing Returns

Utilize the interest rate curves of both countries. For example, if Korean bonds offer higher yields at the same maturity, you can increase Korean bond holdings while maintaining a stable base with U.S. bonds to enhance overall returns.

Large interest rate differentials between the two countries may also present arbitrage opportunities.

( Managing Exchange Rate Risk

Currency fluctuations affect the KRW value of dollar-denominated assets. Hedging)futures contracts###can reduce exchange risk but involve opportunity costs.

Strategy: Hedge only part of U.S. bond investments and keep some exposure to balance risk reduction and return opportunities.

( Duration Management

Duration indicates a bond’s sensitivity to interest rate changes.

• For preserving long-term assets, portfolios with longer maturity U.S. bonds are more stable.
• To reduce sensitivity to rate fluctuations, include bonds with shorter durations.

) Tax Considerations

U.S. bond interest is subject to U.S. federal tax and also taxed in Korea. Fortunately, the Korea-U.S. Double Taxation Agreement(DTA) prevents double taxation on the same income. Consulting a tax professional is essential.

Example Portfolio Composition

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

This setup aims to preserve principal and generate income while reducing dependence on a single country’s economy.

Considering exchange rates:

• When the dollar strengthens: U.S. bonds’ KRW value increases, yielding higher returns.
• When the dollar weakens: Hedged positions offset currency losses.

Hedging 50% of U.S. bonds can reduce volatility while maintaining benefits from dollar appreciation.

Conclusion

U.S. bonds are a global investment asset offering both safety and profitability. Proper understanding of interest rate, inflation, and exchange rate risks is key to success.

Korean investors can choose from direct purchase, funds, or ETFs based on their investment preferences. Combining domestic and U.S. bonds enhances diversification and stabilizes returns, making it an effective strategy.