Treasury bills are short-term government debt obligations with maturities of one year or less and are sold in denominations of $1,000.
T-bills are sold through the U.S. Treasury in auctions through competitive bids for institutional investors and non-competitive bids for smaller investors, said Stuart Michelson, a finance professor at Stetson University in DeLand, Florida.
“The competitive bids determine the pricing and implied interest on T-Bills when they are initially sold at auction,” he said.
Investors like T-bills because these assets pose very little risk since the odds of the federal government defaulting on paying the interest for them is nearly nonexistent.
The low risk comes with the benefit of paying a fixed rate of interest, but the interest rates are generally low. The rates currently range from 0.09% to 0.17% for T-bills that mature from four weeks to 52 weeks.
“T-bills don’t pay periodic interest, instead earning implied interest by being sold at a discount to face value,” Michelson said. “If T-bills are not held until maturity, investors have the additional risk of the price (value) of the T-bill increasing or decreasing due to variations in interest rates.”
The interest rates of T-bills are determined partly by market demand.
“Coupon rates stay the same for the life of the security, but yields fluctuate constantly as supply and demand pushes the price up and down,” said Greg McBride, chief financial analyst at Bankrate, a New York-based financial data company. “The yield is a reflection of the coupon rate, whether the bond is selling above or below face value and how long until the bond matures.”
The interest rates on U.S. T-bills are also determined by the Federal Reserve, the central bankers, said Derek Horstmeyer, an associate finance professor at George Mason University in Fairfax, Virginia.
“We can expect them to stay low for at least another few years since the Fed projects that they will need to keep them low to stimulate the economy and get us out of this recession,” he said. “They may even have to force T-bill rates negative if this continues to get worse in terms of unemployment and economic contraction."
How to Add Treasury Bills to a Portfolio
An investor with a two-year investment horizon could consider a two-year CD versus a two-year Treasury.
“Many money market funds hold Treasury bills, so as those yields fluctuate it can have a direct bearing on the income the investor earns,” McBride said.
Since Treasury yields are largely below 1%, they’re not going to be a great income generator, he said.
“But holding Treasuries, the ultimate safe-haven investment, is a great diversifier of an overall portfolio,” McBride said. “The lack of default risk makes a nice counterbalance to a portfolio of riskier investments such as stocks, real estate, commodities and other higher risk bonds.”
Investors need to match the maturity of the bonds they’re investing in with their time horizon. While Treasuries are free from default risk, they are not immune from sharp price fluctuations prior to maturity.
“If you have a two-year investment horizon, don’t invest in a bond with a maturity longer than two years to avoid getting caught flat-footed,” he said.
Many investors use Treasuries for their emergency funds or health savings accounts (HSA) because they can be a prudent investment for people seeking some return, but with a low possibility of loss, said Daren Blonski, managing principal of Sonoma Wealth Advisors in California.
“Treasuries tend to have minimal fluctuations in value and offer a consistent coupon, albeit not a large payout,” he said. “For most investors, Treasuries serve the role of occupying the less risky sections of their portfolios.”
Since mortgages are frequently packaged together into mortgage-backed bonds, the rates quoted to mortgage borrowers are closely correlated to the movement of 10-year Treasury notes.
“Treasuries are free from default risk and all bonds trade at a spread above Treasuries that reflects the risk of default,” McBride said.
Money market funds hold cash, cash equivalent securities and Treasuries with a short-term maturity.
Investors find money market mutual funds appealing because they are easy to buy and sell.
“These funds work well for investors pursuing investments that preserve principal while earning a stable return,” Michelson said. “Money market mutual funds are insured by the FDIC and regulated by the SEC which regulates maturity, credit quality and liquidity of securities.”
Treasury notes are similar to T-bills because they are also backed by the federal government, but the maturities are longer - two to 10 years and pay interest every six months.
Another similar asset are Treasury bonds that mature in 10 to 30 years and pay interest every six months.
“While T-bonds and T-notes pay higher interest than T-bills, they have more price risk or the risk of the purchase price changing on the secondary market due to their longer term to maturity than T-bills,” he said.
Fixed income is a frequent place investors turn to in times of volatility and many consider government debt as the gold standard when it comes to safe haven assets, said Mike Loewengart, managing director, investment strategy of E-Trade, an Arlington, Virginia-based brokerage company.
“Treasuries come in a few different shapes and sizes but all are backed by the US government so they have a pretty low chance of defaulting,” he said.
When deciding between a T-bill, note, or bond, investors need to factor in the time horizon of these investments and their potential implication to a portfolio. The biggest thing to consider with Treasuries is duration risk because interest rates will cause the market value of the bond to fluctuate over time.
“So the longer the maturity of the bond, the more sensitive it is to duration risk,” Loewengart said. “Bond funds are also no stranger to duration risk, so take that into consideration when deciding between investing directly into Treasuries versus an ETF.”
T-bonds have longer durations compared to T-bills and tend to have a more compelling yield.
“Investing in a T-note may be a Goldilocks solution for investors seeking government bond exposure,” he said. “Despite historically low yields today, Treasuries can certainly provide ballast to a diversified portfolio during extreme market volatility. If you’re zeroing in on retirement, Treasuries may be a prudent investment choice, but young investors could stand to benefit from taking on a bit more risk.”