Treasury bills, or T-bills, are essential to a diversified investment portfolio, as they offer a safe and reliable investment option for fixed-income investors. These short-term debt securities are issued by the government and backed by its full faith and credit, making them one of the safest investments available. This article will explore T-bills’ key features and benefits for fixed-income investors seeking a secure and reliable investment option.
What are Treasury bills?
Treasury bills, often shortened to T-bills, represent a cornerstone of the government’s debt financing. These short-term debt securities are issued with maturities ranging from a few days to one year. When you purchase a T-bill, you essentially lend money to the government for a specific period. Instead of paying interest directly, the government sells T-bills at a discount to their face value.
For example, you might purchase a $10,000 T-bill for $9,800. At maturity, the government repays you the full face value of $10,000. The difference between the purchase price and the face value represents your interest earnings.
T-bills are available in various maturities to suit different investment time horizons. Common maturities include 4-week, 13-week, 26-week, and 52-week bills. These different maturities allow you to choose an investment that aligns with your financial goals and risk tolerance.
Why invest in Treasury bills?
Low risk. Treasury bills are renowned for their exceptional safety. As they are backed by the full faith and credit of the government, the risk of default is extremely low. The government is highly unlikely to fail to repay its debt obligations.
Liquidity. T-bills offer a high degree of liquidity. This means you can easily buy and sell them in the secondary market. This liquidity provides you with flexibility and allows you to access your investment funds when needed.
Tax advantages. Interest income earned from T-bills is generally subject to federal income tax. However, a significant advantage is that they are typically exempt from state and local taxes, potentially enhancing your overall returns.
Predictable returns. While T-bills may not offer the highest potential returns, they provide predictability. You can generally anticipate a stable and consistent income stream from your T-bill investments.
How do Treasury bills work?
Treasury bills operate on a straightforward principle: you essentially lend money to the government temporarily. Instead of paying interest directly, the government issues T-bills at a discount to their face value. This means you purchase the T-bill at a price lower than its stated value. For example, if a T-Bill has a face value of $10,000, you might purchase it for $9,800.
At maturity, the government repays you the full face value of the T-Bill, in this case, $10,000. The difference between the purchase price and the face value represents your interest earnings. In our example, your profit would be $200 ($10,000 – $9,800).
Buying at a discount and receiving the full face value at maturity effectively generates your return on investment. T-Bills are considered zero-coupon securities because they don’t pay periodic interest payments. Instead, your return is realized at the time of maturity.
How to invest in Treasury bills
You have several convenient options for investing in Treasury bills. You can purchase them directly from the government through TreasuryDirect, the official website for buying Treasury securities. TreasuryDirect allows you to open an account online and purchase T-bills electronically.
Alternatively, you can participate in Treasury auctions to acquire T-bills at competitive prices. Furthermore, many brokerage firms offer T-bills as part of their investment options, allowing you to invest in them conveniently alongside your other brokerage holdings.
Considerations for investors
Interest rate risk. It’s important to understand that changes can influence the value of your T-bills in prevailing interest rates. When interest rates rise, the value of existing T-bills may decline. This is because newly issued T-bills will likely offer higher interest rates, making older T-bills less attractive to investors.
Inflation risk. Inflation can erode the purchasing power of your T-bill returns, especially over longer periods. While T-bills offer a degree of safety, the real return (after adjusting for inflation) may be lower than the nominal return.
Opportunity cost. While T-bills provide a safe and predictable return, they generally offer lower returns than other investment options with higher risk, such as stocks, corporate bonds, or longer-term government bonds. You should consider the opportunity cost of investing in T-bills versus pursuing investments with potentially higher returns.
