Long-term Treasury ETFs, led by the iShares 20+ Year Treasury Bond ETF (TLT), have gained investor attention as their interest rate sensitivity can lead to outsized gains in a falling rate environment.
For example, in the past year, TLT’s price has jumped 12%, as inflation has cooled, giving the Federal Reserve the green light to lower its key lending rate (interest rates have an inverse relationship with bond prices).
While these Treasury bond funds can provide investors with a range of benefits, including higher yields and greater long-term returns compared to short-term bond ETFs, there are some risks to consider before buying shares.
Learn how long-term Treasury bond ETFs work, including examples, how they are taxed, and the pros and cons associated with investing in them.
What Is a Long-Term Treasury ETF?
A long-term Treasury ETF is an exchange-traded fund that invests primarily in U.S. Treasury securities with longer maturities, which are generally 10 years or more. These ETFs provide investors with exposure to the long-term segment of the U.S. Treasury bond market by passively tracking a benchmark index, such as the IDC U.S. Treasury 20+ Year Index.
U.S. Treasury securities are debt instruments issued by the U.S. government to finance its operations and pay off existing debt. They are considered to be among the safest investments in the world because they are backed by the full faith and credit of the U.S. government.
However, it’s important to note that long-term Treasury ETFs are not without risks. They are still subject to interest rate risk, inflation risk and the potential for changes in market conditions that can impact the value of the underlying bonds and the ETF itself.
Which ETFs Are Considered Long-Term Treasury?
Long-term Treasury ETFs typically hold Treasury bonds with maturities of 10 years or more. Therefore, ETFs that are considered long-term Treasury may include 10+ year Treasury ETFs and 20+ year Treasury ETFs. These ETFs may also include TIPS ETFs, zero-coupon Treasury bond ETFs and Treasury Strips ETFs.
Types of Long-Term Treasury Bond ETFs
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Broad long-term Treasury ETFs: These ETFs invest in a broad range of long-term U.S. Treasury securities, including bonds with varying maturities. They provide exposure to the entire long-term Treasury bond market.
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10+ year Treasury bond ETFs: These ETFs specifically focus on long-term Treasury bonds with maturities of 10 years or more. Thus, they offer exposure to Treasury bonds that have maturities longer than intermediate term.
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20+ Year Treasury bond ETFs: These ETFs specifically focus on long-term Treasury bonds with maturities of 20 years or more. They offer concentrated exposure to the longest-dated Treasury bonds available.
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Zero-coupon Treasury bond ETFs: Zero-coupon Treasury bond ETFs invest in long-term U.S. Treasury bonds that do not pay regular interest payments. Instead, they are issued at a discount to their face value and mature at par. The ETFs benefit from the accretion of value over time as the bonds approach maturity.
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Treasury inflation-protected securities (TIPS) ETFs: These ETFs invest in long-term Treasury bonds that are adjusted for inflation. TIPS ETFs can provide protection against inflation by adjusting the principal value of the bonds based on changes in the consumer price index (CPI).
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Treasury Strips ETFs: Treasury Strips ETFs invest in long-term Treasury securities that have been stripped of their coupon payments, creating separate securities. These ETFs provide exposure to the principal value of the underlying long-term Treasury bonds.
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Leveraged long-term Treasury ETFs: These funds are designed to amplify the returns (positive or negative) of long-term Treasury bonds by using financial instruments like swaps and futures.
Top Long-Term Treasury ETFs List by AUM
Data as of August 4, 2024. Leveraged ETFs were not included in our search.
The Pros and Cons of Investing in Long-Term Treasury ETFs
Long-term Treasury ETFs have many advantages, including the potential for higher yields and higher long-term returns compared to Treasury bonds with shorter maturities. However, investing in these bonds has multiple risks, such as interest rate sensitivity, for investors to consider.
Here are some of the pros and cons of investing in long-term Treasury bond ETFs:
Pros
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Higher potential returns: Depending on the direction of interest rates, long-term Treasury bonds can potentially produce higher returns than Treasury bonds with shorter maturities.
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Income: Long-term Treasury bonds generally offer higher yields compared to shorter-term Treasury securities. Investing in long-term Treasury ETFs can provide a source of income through the interest payments received from the bonds held in the ETF.
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Safety: U.S. Treasury securities are considered one of the safest investments due to the backing of the U.S. government. Investing in long-term Treasury ETFs provides exposure to these highly regarded securities, which can offer a high level of capital preservation.
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Diversification: Long-term Treasury ETFs can provide diversification benefits to a portfolio. By investing in a broad range of long-term Treasury securities, investors can spread their risk across various maturities and durations.
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Liquidity: Treasury securities are highly liquid, and investing in long-term Treasury ETFs allows investors to buy and sell shares on an exchange at market prices throughout the trading day. This liquidity provides flexibility for investors to enter or exit their positions as needed.
Cons
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Interest rate sensitivity: Long-term Treasury ETFs are sensitive to changes in interest rates. When interest rates rise, the value of existing bonds with fixed interest payments tends to decline. Conversely, when interest rates fall, bond prices tend to rise.
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Inflation risk: Long-term Treasury bonds are susceptible to inflation risk. If inflation rises, the purchasing power of the fixed interest payments received from the bonds may decrease over time.
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Potential for price volatility: Price movements in both directions are more pronounced for bonds with longer maturities. Thus, while Treasury securities are considered relatively safe investments, they can still experience price volatility. The value of long-term Treasury ETFs can fluctuate due to market conditions, investor sentiment and changes in economic factors.
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Lower yields: While long-term Treasury bonds offer higher yields compared to shorter-term securities, their yields may still be relatively low compared to other types of fixed income securities, such as corporate bonds.
How Are Long-Term Treasury ETFs Taxed?
Long-term Treasury ETFs are taxed in a similar manner to other bond ETFs but may offer some tax benefits. For example, income from Treasury bonds is generally taxed as income at the federal level but is tax free at the state and local level. Capital gains tax may also apply to Treasury ETFs.
Here are some key points regarding long-term Treasury bond ETF taxation:
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Interest income: The interest income generated by long-term Treasury bonds held within the ETF is subject to federal income tax. It is generally taxed at ordinary income tax rates.
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State and local taxes: Interest income from long-term Treasury bonds issued by the U.S. government is exempt from state and local income taxes. However, if the ETF holds Treasury bonds issued by a particular state or local government, the interest income from those bonds may be subject to state and local taxes.
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Capital gains: If an investor sells their shares of the long-term Treasury bond ETF at a profit, they may be subject to capital gains tax. The tax rate will depend on how long the shares were held.
Bottom Line on Long-Term Treasury Bond Funds
ETFs that provide investors with exposure to long-term Treasury bonds can be used for a range of purposes, including income and price appreciation. However, it’s important for investors to carefully consider their investment goals, risk tolerance and the current market environment before investing in a long-term Treasury ETF or any other investment product.