Treasury bills for ordinary folks

By Philip Brewer on 17 July 2007 19 comments

Let's say you've paid off any debt, except maybe a low-rate mortgage or student loan, and you've started saving the 3-6 month's spending money that all the books say you ought to have. (Actually, the books all say you should have 3-6 months' income, but they're just assuming that, like most people, you're spending everything you bring home. All you need is 6 months' spending money, which ought to be a good bit less than 6-months' earnings.)

So, where do you put that savings? You want it to be where you can put your hands on it right away, but also someplace where it'll earn a good rate. There are plenty of good choices. If your bank offers a savings account or money market account that pays a good rate, that may be a great choice (but lots of banks don't). A money market mutual fund will pay a good rate and offer access to your account by check. An on-line bank account such as INGDirect is another good choice.

I want to suggest an alternative that gives you the maximum safety and considerable flexibility: treasury bills.

The time was that treasury bills were an esoteric investment only available to the elite. You needed a brokerage account (or at least a friendly banker), plus a minimum investment of $10,000.

Nowadays things are a lot easier. The minimum investment is only $1000, and any US person (citizen or resident) can open a TreasuryDirect account with the Federal Reserve. It's tied with a checking account, much like an on-line bank account. When you buy a treasury bill the money is debited from your checking account. When the bill matures the money will be credited to your checking account, unless you roll it over into a new treasury bill. The account is free and there are no transaction fees.

[Update:  The Treasury announced that, beginning Monday, April 7, 2008, all Treasury marketable bills, notes, bonds and Treasury Inflation-Protected Securities (TIPS) will be available in minimum and multiple amounts of $100.]

In that way, treasury bills work a lot like a CD. One difference is that they are sold at a discount, then pay face value at maturity. So, you might buy a treasury bill for $975 and then get $1000 six months later. The price is established at an auction, but ordinary investors usually enter a non-competitive bid and get the average rate from the auction.

I have half of my emergency fund in my local bank. It doesn't pay a great rate, but it's there if I need it. The other half I have in two 26-week treasury bills with the maturities 13-weeks apart. As long as I don't need the money for an emergency, I just roll over each bill. (That task takes about 2 minutes every three months.) If I need the money for an emergency, I don't need to do anything. In a few weeks the first of those bills will mature and dump a quarter of my emergency fund into my checking account. About 13 weeks later, the last quarter of the money goes in.

So, what are the advantages of a Treasury Direct account?

First, US treasury securities are the safest dollar-based investments you can make. (The government, after all, has people with guns who can go out and take the money they need to pay you--and do so legally. Besides that, they also have the printing presses that let them print the money they need to pay you--and they can do that legally too. Granted, if it comes to the latter scenario the dollars you get may not be worth so much, but that's a different problem.)

Second, you can not only buy treasury bills--an excellent vehicle for a big chunk of your emergency fund--but you can also buy longer-term treasury notes and bonds.

Most people will tell you to put your longer-term money (once you've got your emergency fund covered) into the stock market, because stocks are going to show a superior return over time. I agree with that in general, but there's still a place for investing in bonds: if you know you're going to need the money on a particular date, especially if that particular date is in the next 5 years. Any time you know you need to make a payment (college tuition, house closing, car down-payment, etc.) then the stock market, despite its higher return over time, is an inappropriate risk for that money. If the payment date is soon, then you can keep the money in the same sort of account you use for your emergency fund. But what if the date is 2 to 5 years off? Then a treasury note might be just the thing.

Treasury notes and bonds are longer-term investments. (You can get notes or bonds with maturities of 2, 5, 10 or 30 years.) You buy them at close to face value, and then they pay interest twice a year until they mature, at which point you get your last interest payment and your money back.

Finally, there's another whole category of treasury securities called TIPS--treasury inflation-protected securities--which are like other notes and bonds except that the face value increases to keep pace with inflation. These are available in maturities of 5, 10, and 20 year. They're worth a whole post of their own:  TIPS and I-Bonds.

Oh, and (since the picture above is of savings bonds), I ought to mention that you can put savings bonds into a TreasuryDirect account as well.

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Guest's picture
Jonathan Ploudre

I have to say that if you like the security of a treasury bill, I'd suggest a T-bill based mutual fund like at Vanguard. There is a small expense fee but you get complete liquidity of your money. So if you actually need the money for a big emergency, you can get to all of it. Worse case scenario for above, you'd have to wait 12 and 25 weeks to get the second half of your money.

Philip Brewer's picture

It's possible to sell a t-bill out of a TreasuryDirect account, if you have to. You get the market rate (so you're no longer guaranteed to get face value) and there's a fee. (Although it's cheap compared to getting a broker to do it, it can be a large percentage of the money you're getting, especially if your emergency fund is small.)

Still, you're generally right, and that's why I only keep half my emergency fund in the t-bills. For a large class of emergencies (such as losing a job), you don't really need the money right now, you just need to be really, really sure the money will be there when you do need it. You need to make a judgement call about the kinds of emergencies you might face.

There are two problems with using a mutual fund. First, even a low-cost fund can eat up a good bit of the total return, because the interest rates on cash are often low. Second, you lose some of the biggest advantage--the safety of the investment--because you no longer own a direct obligation of the US government. Instead, the mutual fund owns a direct obligation of the US government and you own a share in the mutual fund. I doubt if that makes much difference in practice, but if you don't care about that tiny increment in safety, you'd probably get about the same return in an on-line bank.

Guest's picture

Just a minor correction. The US Government can not legally print money. This is all done through the Federal Reserve System at the request of the Treasury. The Fed can even deny the request (I don't know if they ever have).

From the Fed's FAQ:
"As the nation's central bank, the Federal Reserve derives its authority from the U.S. Congress. It is considered an independent central bank because its decisions do not have to be ratified by the President or anyone else in the executive or legislative branch of government, it does not receive funding appropriated by Congress, and the terms of the members of the Board of Governors span multiple presidential and congressional terms."

Another (very funny) quote:
"Although they are set up like private corporations and member banks hold their stock, the Federal Reserve Banks owe their existence to an act of Congress and have a mandate to serve the public. Therefore, they are not really "private" companies, but rather are "owned" by the citizens of the United States."

This is complete bull of course - each regional bank (there are 12) is run as a private corp and compete with the other banks for contracts from the Treasury.

Further down this is backed up by the following:
"Are Federal Reserve Bank employees considered government employees?

No. Employees of the Federal Reserve Banks are not government employees. They are paid as part of the expenses of their employing Reserve Bank."

Each bank is also responsible for certain specific tasks, for example the Dallas FRB is one of the banks which is responsible for the destruction of old currency.


Philip Brewer's picture

But I would note that the Bureau of Engraving and Printing is part of the Treasury and not part of the Federal Reserve. It may be that the Federal Reserve is their only legal customer at the moment, but Congress could change that at any time.

In any case, I was treating the government as a whole. The constitution gives Congress both the power to tax and the power to issue money. They may delegate the different pieces of those powers to various different institutions, bureaus, and services, but I have considerable faith that they'll do whatever taxing and printing is necessary to make good on my treasury bills.

Guest's picture

From the US Treasury FAQ:
"Both United States Notes and Federal Reserve Notes are parts of our national currency and both are legal tender. They circulate as money in the same way. However, the issuing authority for them comes from different statutes. United States Notes were redeemable in gold until 1933, when the United States abandoned the gold standard. Since then, both currencies have served essentially the same purpose, and have had the same value. Because United States Notes serve no function that is not already adequately served by Federal Reserve Notes, their issuance was discontinued, and none have been placed in to circulation since January 21, 1971."

You are correct the BEP prints all money, but it is done solely at the request of the Fed, as described in Section 16 of the Federal Reserve Act. There are many who feel that this is unconstitutional, but it has never (to my knowledge) been challenged. Even if it has been challenged, obviously it wasn't successful.

You are also correct that congress could bring in an alternative to the Fed at any time, but I really don't see that happening. They are to invested in it at this point.

Anyway, none of this is meant to detract from your post, which was great.


Guest's picture

"You buy them at close to face value, and then they pay interest twice a year until they mature, at which point you get your last interest payment and your money back."

This seems like it might suggest that the interest gets paid out instead of reinvested. If so, does that mean that you lose out on the compounding of this interest?

Philip Brewer's picture

The issue you're talking about is real.  Bond specialists refer to it as "reinvestment risk":  the risk that, when you go to reinvest the interest payments, you end up having to invest at a lower rate.  (To that, of course, you have to add the "lazy investor risk" and "spendthrift investor risk" that you'll either not get around to investing the money at all, or worse yet, just spend it.  The bond specialists would never do such a thing, so they don't have a name for it.)

If interest rates are higher when you receive your interest payments, you're golden:  reinvest the money at the higher rate.  (Of course, you still have to actually do it.)  Similarly, if your plan is to spend the money (because you're already retired, let's say, and the interest is what you're planning to live on), then getting the interest paid out is just what you want.

If you definitely want to be compounding, and you're concerned that future rates might be lower, there's another option called a zero-coupon bond.  It doesn't pay semi-annual interest payments.  Instead, you buy it at a big discount to face value and then it pays off at face value at maturity.  The result is guaranteed compounding.  I'm not sure you can buy those directly in a Treasury Direct account, although you can definitely get them through a broker.

Guest's picture

Can a company (corporation) buy t bills from the Treasury?
All the forms are set up for individuals.

thanks, Marg

Philip Brewer's picture

Yeah, the new Treasury Direct seems to be just for individuals.  The old Treasury Direct was somewhat more flexible (at least about joint ownership), but I think even it was not set up for anything but ownership by natural people.

Guest's picture

I am thinking of investing money we are saving for future car, vacation and housing downpayments in this manner, rather than going through vanguard. How do you find the interest rate on the treasury dircet web site?


Philip Brewer's picture

The rate on t-bills is determined by auction, so one of the downsides is that you don't know what rate you're going to get until after you've already bought the t-bill.  On the other hand, you're getting the rate determined at auction, so you're getting the same rate the big-time financial types are getting--it's genuinely a market rate.

You can see what the rate is on current t-bills various places.  Here's one, at Bloomberg:

The three-month and six-month bills are shown in the first two lines of the first chart.

Currently, rates on short-term government paper are terrible.  (Actually negative on 3-month bills as I type this.)  You can almost certainly do better on bank CDs right now.  That will change, as the government's borrow needs eventually push up short-term rates.  (So, if you're reading this comment months from now, be sure to check and compare rates.)

Guest's picture

What's the differance between T Bills with lets say a
(Gold Seal) or a (Red Seal) or a (Silver Seal) on them???

Philip Brewer's picture

I'm guessing that you're asking about ordinary banknotes (i.e. money), as T-bills aren't printed on paper anymore.  (They haven't been in for long time.  Their ownership is tracked electronically by the Federal Reserve.)

Almost all the ordinary banknotes that you find in circulation now are Federal Reserve Notes, but in the past there have been different kinds of banknotes, issued by the treasury (and before that, by other banks).  They generally look pretty similar, but (as you indicate) have different colored seals.  They also have different text at the top (where most of the money in your wallet currently says Federal Reserve Note).  The most common other kinds are United States Notes, Silver Certificates, and Gold Certificates.

If they're in really good shape they may be worth something to a collector of currency.  Aside from that, for practical purposes they're really just like Federal Reserve notes--they're still valid US money, worth whatever the donomination is.  Neither gold nor silver certificates can be turned in for gold or silver--the last date to do that was decades ago.

Guest's picture

how can t-bills impact on the poor and the developing countries?
l am in a part of the world where income level is low and culture of saving.

Guest's picture

Can I make a profit if I sell a T-Bill before its maturity date? If so could you include a full example to show how the profit is computed including the treatment of the remaining discount value?



Philip Brewer's picture

It is possible to make a profit selling a t-bill before maturity. In fact, it's likely--under normal conditions the yield curve is upward-sloping (meaning that shorter-term t-bills earn a lower yield), so your t-bill should grow in price slightly faster than straight-line appreciation.

I'm afraid, though, that I can't help you with the tax question.  Because the tax laws and rules change all the time, I long ago gave up trying to figure stuff out in advance, and I've never sold a t-bill before maturity myself.  So I've never had to figure it out.  Anyway, each individual tax situation is unique, so one-size-fits-all advice is rarely useful.

Guest's picture

When t-bills are returning 0% is this an indication that large funds are buying in? If so, when has this historically happened? What can the average investor learn from this?

Philip Brewer's picture

 As a response to the financial panic, the Federal Reserve started pushing interest rates down in 2007, and kept pushing them down until reaching zero in late 2008.  The Fed can control short-term interest rates because it can create or destroy money--adjusting the supply to whatever produces the interest rates it wants.

This is pretty much a unique situation historically in the United States, but other countries (in particular Japan in the 1990s) have tried what's called a "zero interest rate policy."

The average investor is pretty much stuck waiting for rates to go up.

Guest's picture

Great article! So, in todays market, if I were to buy $1000 worth of T-bills and the interest rates don't rise appreciably in the next 6 mos., approximately what would be the return on my investment? Sorry if this is a lame question!