Government Bond Funds

Government bond funds, also known as Treasury bond funds, are a type of mutual fund that invests by lending the U.S. government money through the purchase of U.S. Treasury bills, bonds or notes. In addition, agencies of the U.S. government, such as the Government National Mortgage Association (Ginnie Mae), the Federal Housing Administration (FHA), and the Farmers Home Administration (FmHA), also issue mortgage-backed bonds that these government bond funds invest in.

Tip Another type of mortgage-backed bond is a real estate mortgage investment conduit (REMIC). REMICs are similar to other mortgage securities, but the difference is that mortgage payments applied to the property make up the collateral for the bonds issued. Also, depending on the type of interest you own in a REMIC, different tax treatment of income may result.

What's the biggest advantage of investing in treasuries? That's easy--there's practically no risk involved. Their safety lies in the fact that they're obligations of the federal government. The chance that the federal government will renege on you is pretty close to nil. In other words, in the world of investment vehicles, U.S. treasuries are as close to a sure thing as you'll ever get.

Bonds issued by government agencies, such as mortgage-backed bonds, are not quite as risk-free as bonds issued by the government itself (although they are still pretty high on the safety ladder), so they usually pay a bit more (perhaps one or two percentage points at most) in interest than government bonds do.

Another advantage that treasuries (and some bonds issued by government agencies) have is that the interest you receive is not taxed at the state or local level. This may help to offset the disadvantage of treasuries, namely that the interest rates that they pay are on the lower end of the scale. However, a low interest rate is to be expected with such a low-risk security.