Easy Income with T-Bills

Written By Brian Hicks

Posted March 3, 2015

For a good dose of capital preservation, investors have historically turned to Treasury securities.

T-bills, notes, bonds, and bond funds offer investors the stability they want from their investments, if not the returns they need to stay ahead of inflation.

Take 10-year Treasury notes, where rates of return stood just north of 2% in recent years and are heading down to 1.70% in 2015, analysts estimate. That’s a far cry from the 4.52% yields investors saw in mid-2007, just before the onset of the Great Recession.

But T-bill rates of return are even worse, with the one-year rate of return on Treasury bills at a miserly 0.17% as of February 2015.

Treasury Bills Defined

According to the U.S. Treasury Department, a Treasury bill, or T-Bill, is short-term debt issued and backed by the full faith and credit of the United States government. These debt obligations are issued in maturities of four, 13, 26, and 52 weeks in various denominations as low as $100.00.

Structurally, Treasury bills are different than most fixed-income instruments. T-bills don’t pay interest based on the return models of other bonds. Instead, Treasuries offer a discount based on the security’s maturity value — basically the appreciation between the Treasury security’s issue price and the maturity price.

Here’s how the U.S. Treasury Department defines how T-bills work in real-world terms:

A 26-week T-bill is priced at $9,800 on issuance to pay $10,000 in six months. No interest payments are made. The investment return comes from the difference between the discounted value originally paid and the amount received back at maturity, or $200 ($10,000 – $9,800). In this case, the T-bill pays a 2.04% interest rate ($200 / $9,800 = 2.04%) for the six-month period.

Benefits of T-Bills

Treasury bills are deemed “risk free” by investment professionals, and — with some notable exceptions — there’s a good reason for that.

With T-bills, investment returns are guaranteed via the full faith and credit of the U.S. government.

Additionally, T-bills offer investment stability, as they’re fairly well insulated from any interest rate risk.

As rates rise, the value of most fixed-income investments declines, primarily because the relative value of the bond’s future income is discounted. Treasury bills are short-term fixed-income investments and are thus insulated more than longer maturity bonds, as steeper interest rates have a muted effect on potential income streams.

Tax-wise, Treasury bills are a good deal for investors, as they’re exempt from state and local taxes. (By law, states cannot tax federal bonds, which is also why the federal government can’t tax state and local municipal bonds — based on so-called “reciprocal immunity” statutes.)

Treasuries also offer a high level of liquidity. By law, 20 primary dealers are required to buy a substantial amount of Treasuries every time an auction makes securities available, and those dealers must be prepared to trade those securities in the secondary market.

They’re also easy to buy, either through brokerage companies and banks or directly from Uncle Sam at the TreasuryDirect website. Note that T-bills are sold at a discount and that the discount rate is determined at the Treasury auction.

In addition, all T-bills — with the exception of 52-week bills — are auctioned every week. The 52-week bill is auctioned every four weeks.

Difference Between U.S. Treasury Bills, U.S. Treasury Bonds, and Notes

               Minimum denomination Sold at      
Maturity
T-Bills $100.00 Discount 4-52 weeks
T-Notes $1,000.00 Coupon 2-10 years
T-Bonds $1,000.00 Coupon 30-years

*T-bills offer interest and principal paid at maturity, while T-notes and T-bonds offer interest paid semi-annually and principal at maturity.

Treasury Bills Risk at a Glance

Treasury bills are widely considered to be highly risk averse, but that doesn’t mean they are completely risk-free. Here’s a snapshot of the risk ramifications and benefits of Treasury bills:

  • There is zero call risk and virtually zero liquidity, event or credit, and default risk.

  • Interest rate risk: If interest rates rise, the value of your bond on the secondary market may decline.

  • Inflation risk: Treasury bill rates of return don’t usually keep up with the rate of inflation, which stands at approximately 2% in 2015. Meanwhile, six-month T-bill rates stand at around 0.07%.

  • Opportunity risk: The longer the term of your U.S. Treasury security, the greater the chance you may miss out on a better investment opportunity should one become available (as your cash is tied up in a Treasury deal). That’s not as big a deal with T-bills, which offers shorter maturities.

The Best Ways to Leverage Treasury Bills:

  • Diversify your investment portfolio
  • Participate in a secure, short-term investment
  • Capitalize on short-term shifts in U.S. interest rates

Average Treasury Bill Yields (as of February, 2015)

Duration Rate
30 Days 0.01%
90 Days 0.02%
180 Days 0.07%
365 days 0.17%

Source: Treasury.gov

The End Game: Are Treasury Bills For You?

Treasury bills can provide capital preservation — but not much investment appreciation — for your long-term investment portfolio.

They are guaranteed by the full faith and credit of the U.S. government, so there is no risk of default or your losing any money on the deal.

For a rock-solid “parking spot” for your money for a year or less, Treasury-bills are a stable investment — as long as you’re not looking to get rich on the deal.

Until next time,

Brian O’Connell for Wealth Daily

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