Treasury bills for ordinary folks
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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