Treasury ETFs: What They Are and How They Work

Treasury exchange-traded funds (ETFs) trade like stocks on the major exchanges. They hold a portfolio of U.S. Treasury securities, with each ETF differing in time to maturity from less than a year up to 30 years. First introduced in the early 2000s, they have grown in popularity, and there are now more than 50 of them to choose from.

Typically not as exciting as other securities, Treasury securities’ swings have meant that those seeking to lower the overall risk of their portfolio might want this part of their holdings managed professionally.

Since the COVID-19 pandemic, substantial changes in interest rates have happened worldwide, with the United States being a prime example. The overall shift can be seen in the moves of the U.S. 10-year Treasury yield, which hit a record low of 0.33% in March 2020, then surged to a high of 5.02% in October 2023, before settling to around 4.5% in early 2024. These dramatic changes came from disruptions in the supply chain, persistently high post-pandemic inflation, and most significantly, the ratcheting-up of interest rates by the U.S. Federal Reserve.

Treasury ETFs stand out for their lower costs than other ETFs, tax efficiency, and exposure to varying lengths of maturity and bond coupons. Treasury ETFs present minimal risk, making them an attractive choice for those navigating the evolving interest rate landscape.

What Are Treasury ETFs?

Treasury ETFs are designed to track the performance of Treasurys, including short-, intermediate-, and long-term maturities of Treasury bills (maturity of a year or less), notes (one to 10 years), and bonds (20 or 30 years). They provide investors with an efficient and convenient way to gain exposure to U.S. government debt with the convenience of doing so from a brokerage account.

Investors typically use Treasury ETFs for income generation, capital preservation, and portfolio diversification. They are particularly popular among conservative investors and those seeking a stable, government-backed income stream. More aggressive investors tend to use Treasury ETFs to speculate on changes in interest rates. Like all investments, they are not without risks, particularly interest rate and inflation risks.

Key Features of Treasury ETFs

U.S. Treasurys are backed by the full faith and credit of the U.S. government, making them just about the safest investment option available. Low-risk and traded like stocks, Treasury ETFs are also highly liquid. This means you can buy and sell shares of the ETF throughout the trading day at market prices, providing the flexibility you wouldn’t have if you bought the Treasurys yourself.

It’s important to understand how U.S. Treasurys are priced, since their value depends heavily on changes in interest rates. In general, as interest rates rise, existing bonds tend to decrease in value, and conversely, as rates fall, bond values increase. This affects Treasury ETFs and the aggregate value of the U.S. Treasury they hold, so understanding how interest rates influence them is important to know.

Treasury ETFs are also valued for how they diversify investment portfolios. Given their historically low correlation with stocks and other asset classes, they can serve as a hedge against market volatility or economic downturns. This makes them attractive for lowering the overall risk of a portfolio.

It’s important to note that Treasury ETFs are fixed-income instruments. They come with differing yields and durations, depending on the maturities of the bonds they hold. Short-term Treasury ETFs are typically less sensitive to changes in interest rates and offer lower yields, while long-term Treasury ETFs are more sensitive to interest rate fluctuations but usually have higher yields. This means you can choose the ETF containing the Treasurys that best match your investment horizon, financial goals, and risk tolerance.

How Treasury ETFs Work

ETFs are traded on stock exchanges, like individual stocks. They combine the diversification offered by mutual funds with the liquidity and ease of trading of a stock.

The key, of course, is that these ETFs hold U.S. Treasurys, which are debt instruments issued by the U.S. Department of the Treasury. These include Treasury bills, notes, and bonds.

Most Treasury ETFs are passively managed and are designed to track the performance of a particular Treasury bond index. Each index has its criteria, such as the maturities and the type of Treasurys included.

Treasury ETFs have large institutional investors, known as authorized participants, that can create new shares of an ETF or redeem them. This is done by delivering the underlying securities to the fund in exchange for ETF shares (creation) or vice versa (redemption). This helps to keep the ETF’s market price close to its net asset value.

Though traded on exchanges like stocks, Treasury ETFs do not pay dividends. Instead, they pay interest income, called distributions, from the underlying Treasury securities. Distributions are usually done monthly and can vary depending on interest payments received from the Treasurys in the ETF’s portfolio.

Like other ETFs, Treasury ETFs charge a fee for managing the fund. This is called the expense ratio and is typically lower than that of actively managed funds.

In the United Kingdom, India, and other commonwealths, the equivalent of a U.S. Treasury security is a gilt security. These trade through gilt ETFs and mutual funds.

Types of Treasury ETFs

Treasury ETFs can cater to different investment strategies and risk profiles. Some short-term Treasury ETFs put money into Treasury securities with less time to maturity—generally, less than three years. There are intermediate-term Treasury ETFs, which invest in Treasurys with maturities from three to 10 years. Long-term Treasury ETFs hold securities with maturities greater than 10 years.

Another category of Treasury ETFs is for those that hold Treasury inflation-protected securities (TIPS). The principal value of TIPS adjusts with inflation, as measured by the Consumer Price Index.

There are also floating-rate Treasury ETFs. These ETFs put money into Treasury floating rate notes (FRNs), whose interest adjusts according to short-term interest rates. These offer protection when interest rates rise (and existing bond values decline).

The last funds we review are zero-coupon Treasury ETFs, which invest in Treasury STRIPS (an acronym for separate trading of registered interest and principal of securities). These are zero-coupon bonds created by separating the interest and principal of Treasury notes and bonds. They are bought at a discount and mature at face value, with the difference representing the interest earned.

What to Consider When Investing in Treasury ETFs

As with any other investment, you’ll want to review how a Treasury ETF fits with your goals and risk tolerance. Initially, you’ll need to assess the broader economic environment and monetary policy of the U.S. This can significantly influence Treasury securities.

Another factor to consider for Treasury ETFs and fixed-income investments in general is interest rates. When rates rise, the value of existing bonds tends to fall, and vice versa. Treasury ETFs hold a portfolio of U.S. Treasurys, and thus the value of these ETFs comes from the aggregate of all the Treasurys in their portfolios. Also, longer-duration ETFs are generally more sensitive to interest rate changes than shorter-duration ETFs.

The duration and maturity of the Treasury securities in the ETF should also be considered. Short-term Treasury ETFs are less sensitive to interest rate changes but typically offer lower yields, while long-term Treasury ETFs are more sensitive but often have higher yields. Investors should also assess the yield of the Treasury ETF, which depends on the underlying securities’ maturities and current interest rates. Higher yields often come with more risk.

You should check the trading volume and liquidity of any Treasury ETFs you consider. This means that an ETF’s shares are easier to buy and sell without affecting the price. You should also review each ETF’s expense ratio. A lower expense ratio can be more cost-effective, especially for long-term investments, though a badly managed ETF will likely cost you more in the long run, no matter the fees.

Treasury ETFs carry specific implications for your taxes, including interest income and potential capital gains. We discuss this further below.

Pros and Cons of Investing in Treasury ETFs

Benefits of Investing in Treasury ETFs

There are several reasons why Treasury ETFs have grown in popularity:

• Accessibility: Treasury ETFs are widely accessible, since they can be bought and sold like stocks through a brokerage account. There is no minimum investment, as is the case when investing directly in some Treasury securities, most of which are sold in increments of $100 and may start at a minimum of $1,000. For Treasury ETFs, generally, you don’t need to invest in specific increments.
• Cost-effectiveness: Treasury ETFs have relatively low expense ratios compared with actively managed funds. This can increase returns over time.
• Credit quality: Treasury ETFs hold U.S. Treasury securities, the benchmark for risk-free investments.
• Hedge against inflation: Treasury ETFs that hold TIPS and FRNs can offer protection against inflation. In addition, by taking positions in Treasury ETFs with different maturities, investors can manage interest rate risk—that is, the potential for losses from rate changes.
• Income: Treasury ETFs provide a regular income stream through interest payments from the underlying Treasurys. This can be particularly appealing to income-focused investors, such as retirees.
• Liquidity: These instruments can be bought and sold on the stock exchange during trading hours. This liquidity is essential when quickly entering or exiting a position.
• Tax efficiency: ETFs often have tax advantages over mutual funds because of their unique creation and redemption process, which can lower capital gains distributions. On top of that, income from Treasurys is generally exempt from state and local, but not federal, taxes. This affects the ETFs and their distributions.
• Transparency: ETFs are publicly traded and disclose their holdings regularly. This lets you see exactly what you own through your shares in a Treasury ETF.
• Variety: More than 50 Treasury ETFs are available, giving you different ways to position yourself depending on how interest rate yields look today and over time (called the yield curve). This largely depends on the interest rate outlook and investment horizon.
  

Risks and Limitations of Treasury ETFs

Treasury ETFs also have risks, so it’s important to review how Treasury ETFs fit into your overall investment strategy and risk tolerance. Here are some of their drawbacks:

• Interest rate risk: This is the most significant for Treasury ETFs. When interest rates increase, the price of existing bonds typically decreases, and vice versa. Longer-duration Treasury ETFs are more sensitive to interest rate changes than shorter-duration ETFs.
• Expense ratios: While generally lower than actively managed funds, Treasury ETFs still charge an expense ratio, affecting your net returns in the long run, especially since buying Treasurys directly from the U.S. Treasury has no fees.
• Fiscal and monetary policy changes: Changes in fiscal and monetary policies affect economic conditions, Treasury yields, and the distributions of Treasury ETFs.
  
• Market risk: While the government backs U.S. Treasurys and they are very safe, Treasury ETFs can still undergo market volatility. Prices can fluctuate based on market sentiment, economic data, and geopolitical events.
• Opportunity costs: Investing in Treasury ETFs may result in an opportunity cost, especially if other investment classes, such as stocks, are outperforming. Treasurys are low-risk, but this comes with potentially lower returns.
• Relatively low yield: Treasury securities may offer lower yields than other (higher-risk) fixed-income investments and equities. This could lead to less income for those relying on Treasury ETFs.
• Tax considerations: Interest income from Treasury ETFs is subject to federal income tax, though it is typically exempt from state and local taxes. In addition, any capital gains from selling ETF shares are subject to capital gains tax.
• Tracking error: Treasury ETFs track the performance of a specific Treasury bond index. However, there can be tracking errors, meaning the ETF’s performance might slightly differ from that of the underlying index.
  

While Treasury ETFs offer safety and diversification, they should be part of a well-executed portfolio strategy rather than stand-alone investments.

How to Invest in Treasury ETFs

Buying shares of Treasury ETFs involves several simple steps. If you already invest in the stock market, you’re halfway there. First, before placing an order, evaluate your financial goals, investment horizon, and risk tolerance. How does a Treasury ETF fit into your overall portfolio strategy?

Next, research Treasury ETFs and review their maturity profile, yield, expense ratio, and performance history.

If you’re a first-time investor, you’ll open a brokerage account next. Choose a reputable broker that aligns with your needs, considering trading fees, platform usability, and available research tools. Once you’ve selected a brokerage and opened an account, you’ll need to put funds into it.

Following this, based on your research and investment goals, choose a Treasury ETF that meets your criteria. Here are some questions to ask:

• What range of U.S. Treasury bonds does the ETF hold (short-, intermediate-, long-term)?
• How does the yield of this ETF compare with other Treasury ETFs?
• What is the expense ratio of the ETF, and how does it compare with the other ETFs?
• How liquid is this ETF? Can I quickly buy and sell its shares?
• Does this ETF align with my investment strategy and risk tolerance, especially considering the safety and low risk I expect from Treasury bonds?

Once you’ve chosen one, you’ll buy shares in the ETF. But this doesn’t end the investing process—in a sense, it’s just starting. You’ll have to check the performance of the securities as part of your overall portfolio. You’ll look for changes in economic conditions, interest rates, and other factors affecting the ETF’s performance.

You should also review your entire portfolio periodically to ensure it aligns with your investment goals and risk tolerance. Shift your investments when needed. Investing in Treasury ETFs can be worthwhile for diversifying most portfolios, offering safety, income, and liquidity. However, like all investments, it’s essential to do your research or seek advice from a financial advisor to ensure any investment is right for you.

Top Treasury ETFs Compared

The table below provides data on the top and largest Treasury ETFs by assets under management (AUM). The combined AUM of the top 10 Treasury ETFs is about $257 billion, with an average AUM of about $25.66 billion. This is a strong presence in the market, highlighting investor interest in these ETFs. The largest is the iShares 20+ Year Treasury Bond ETF (TLT), which has $48.48 billion in AUM.

These ETFs are notably consistent in their fees. The average expense ratio is 0.11%, with the lowest—the Vanguard Short-Term Treasury ETF (VGSH)—at 0.04%, and the highest—the iShares TIPS Bond ETF (TIP)—at 0.19%. The distribution yield varies from 2.69% for the iShares US Treasury Bond ETF (GOVT) to 4.91% for the SPDR Bloomberg 1–3 Month T-Bill ETF (BIL). The average distribution yield is 3.48%.

The average yield to maturity (YTM) for these 10 Treasury ETFs spans from 3.90% to 5.36%, with the average at 4.54%. The lowest average YTM is for the Vanguard Intermediate-Term Treasury ETF (VGIT), while the highest is the iShares 0–3 Month Treasury Bond ETF (SGOV).

The maturity of the ETFs’ basket of Treasurys can differ across these ETFs. The fund with the shortest weighted-average maturity, SGOV, is just 0.09 years. The longest, TLT, is 25.62 years. The average maturity for the list below is 5.86 years.

The Bottom Line

Treasury ETFs offer investors exposure to U.S. Treasury securities, ranging from short-term bills to long-term bonds. There are also inflation-protected and floating-rate Treasury ETFs. These ETFs pool investors’ money to purchase a portfolio of Treasurys, aiming to replicate the performance of specific bond indexes.

Like stocks, they are traded on exchanges, combining the liquidity and ease of stock trading with the creditworthiness of the U.S. government. With their large variety of maturity profiles, yield potential, and sensitivity to interest rates, Treasury ETFs are a flexible and cost-effective tool for investors to manage risk, generate income, and diversify their portfolios.