Treasury Bills: What to Know Before Considering an Investment in T-Bills
When it comes to getting more out of your savings, there are a lot of different financial instruments to choose from. With so many options, you’re probably wondering which is best for you.
Treasury Bills (T-Bills) are a popular choice for those looking for a lower-risk investment option.
So what are T-Bills and how do they work? Read on to learn more, and discover if they might be right for your financial goals.
What is a Treasury Bill (T-Bill)?
Treasury Bills are short-term debt securities issued by the U.S. Government that mature over a period of time (this length of time is known as the “term” of the bill). In other words, the government sells small portions of its debt and basically writes an IOU to the investor that they will pay them back what they invested plus interest.
Treasury bills range in value, and are typically sold in denominations of $100, but can be purchased for up to $10 million. T-Bills can take anywhere from 4 to 52 weeks to mature.
T-Bills are initially bought for less than their face value. This means that the 'interest' they afford isn't paid out until the maturity date is met.
How do Treasury Bills (T-Bills) work?
When you buy a T-Bill, you buy it at a discount from its face value, wait for a set length of time, and then get the full face value back once it matures. The difference between the amount you paid and the full face value you get back is the interest you earn.
T-Bills can be purchased in three different ways:
A non-competitive bid
A competitive bid
The secondary market
Auctions for T-Bills occur every four weeks for 52-week bills and weekly for 4, 8, 13, 17, and 26-week bills.
The money the government gets for T-Bills is used to pay for its expenses, from construction projects and roadwork to military spending and employee salaries. While most investors will typically hold T-Bills until their maturity date, some cash out early and resell the investment in the secondary market to try and gain from short-term interest.
Because they are issued by the government, Treasury Bills are backed by the full faith and credit of the US Government. This backing makes many investors consider T-Bills a safe and conservative investment.
Types of T-Bills
Often investors refer to T-Bills types as the length of time it takes for them to mature (i.e. 17-week T-Bills, 52-week T-Bills). The most common types will be 4, 8, 13, 17, 26, or 52 weeks.
Good to know: It’s a bit of a misnomer, but 4-week T-Bills are often called 30-day T-Bills.
The type of T-Bill that you may want to invest in will depend on the length of time you are willing to hold it, limiting your access to funds, as well as how much you can earn, which is determined by the price and Treasury Bill rate.
How are Treasury Bills priced?
The value of a T-Bill is known as the par value (also known as face value), which is how much it will be worth if it’s held to the term end date. When you purchase a T-Bill, you pay a discounted price and not the full par value.
Term to know: The difference between the par value and how much an investor pays for a T-Bill is known as the discount yield. The discount yield is also called the Treasury Bill rate.
For example, if you buy a T-Bill with a face value of $1,000 for a discounted price of $970, the discount yield or Treasury Bill rate would be calculated from the $30 difference between these two amounts. Once the T-Bill matures, you receive the face value amount — in this case, $1,000. The profit you make, which effectively serves the function of 'interest' in other financial instruments, is the $30 difference between the purchase price and the face value.
To illustrate this with a real-world example, let's consider the 4 week treasury bill rate. Historically, these rates have fluctuated based on market conditions, making them a dynamic aspect of T-Bill pricing. For example, during periods of economic stability, the 4 week treasury bill rate might be relatively low, but during times of economic uncertainty, this rate may increase. This fluctuation impacts the pricing and yield of T-Bills, demonstrating the interconnectedness of these financial instruments.
Remember: T-Bills do not pay interest until they reach their maturity date.
Factors that affect Treasury Bill rates
T-Bill pricing fluctuates based on many factors, including federal policy, supply and demand, and macroeconomic conditions such as:
Interest rates and maturity: When interest rates are rising, shorter-term T-Bills may be discounted less than those that have later maturity dates. Vice versa, when interest rates drop, longer-term T-Bills may be discounted less.
Market risk: Investor risk tolerance tends to increase when the economy is expanding, making more conservative investments like T-Bills less popular. As a result, T-Bills tend to be priced lower when the market is performing well. On the other hand, during difficult times like a recession, investors may prefer more conservative approaches, driving up the demand and price for lower-risk financial instruments like T-Bills.
The Fed: T-Bill rates typically move closer to the Federal Fund Target Rate, impacting both existing T-Bills and newly issued T-Bills. Since the T-Bill interest rate is set when it is sold, shifts by the Fed can make investors wish to sell or buy existing T-Bills based on how their prices will vary from later issued bills.
If the Fed raises interest rates, investors tend to sell T-Bills since the set yield will be at a lower rate than newly higher-yielding investments.
If the Fed lowers interest rates, more investors may buy T-Bills when the set rate is higher than new interest rates.
Inflation: Even though T-Bills are considered one of the safest debt securities in the market, inflation rates can rise higher than the T-Bill interest rate, meaning an investor would see a net loss. For instance, imagine a scenario where a T-Bill yields just 2% while inflation is at 3%. That means that investors may earn less on their T-Bill than if they had invested in other higher-yielding investments during the same timeframe.
How to purchase Treasury Bills
If you would like to buy T-Bills, you can purchase them on either the primary or secondary markets.
The primary market is an auction on the TreasuryDirect site to purchase the bills directly from the government. Bidders can include individual investors, banks, hedge funds, and primary dealers.
Once bills have been purchased on the primary market, they can be resold to other customers on the secondary market.
Non-competitive bid
A non-competitive bid is placed on the primary market. With this bid, you can submit a bid to purchase a set dollar amount of T-Bills based on the discount rate that is decided at auction. The yield from these bills is based on the average auction price that was bid by all investors.
Competitive bid
With a competitive bid, you determine the specific discount rate that you are willing to pay and place a bid on the primary market.
Keep in mind: The higher the discount price you pay, the lower the discount rate you earn.
Bids that have the highest discount price are accepted first. Once those have been accepted, bids at a lower discount price will be accepted until all the bills issued have sold. Payment for these T-Bill purchases must be made through a bank or broker.
Secondary market
Large market players such as retail and investment banks often resell Treasury Bills on the secondary market. These major institutions aim to make a profit by selling T-Bills at a higher price than they paid for them, benefiting from the 'bid-ask spread' - the difference between the price they're willing to buy (bid) and the price they're willing to sell (ask).
Real example of a Treasury Bill purchase
On September 14, 2023(1), a 4-week T-Bill with an issue date of September 19 and a maturity date of October 17 sold for $99.588944 per $100. If you had purchased a $1,000 4-week T-Bill that day, you would have paid $995.88944, then received $1,000 when it reached maturity. That would be a $4.22177 total in interest gained.
T-Bills, T-Notes, and T-Bonds: What are the differences?
T-Bills are not the only debt security you can purchase from the government. Other fixed-income investments include Treasury Notes (T-Notes) and Treasury Bonds (T-Bonds). All three are sold by auction on the primary market in increments of $100, but there are key differences.
T-Bills: A short-term investment option with the shortest maturity periods from 4 to 52 weeks. The interest or discount yield is paid all at once when the bill reaches the maturity date.
T-Notes: A medium-term investment option with maturity periods of 2, 3, 5, 7, or 10 years. T-Notes offer coupon payments every six months, so investors are paid interest twice a year.
T-Bonds: A long-term investment option with maturity periods of 20 or 30 years. Like T-Notes, T-Bonds pay interest twice a year to investors.
Potential advantages and disadvantages of T-Bills
As with all financial instruments, you have to find the right investment to fit your strategy. There are a number of advantages and disadvantages you should keep in mind for T-Bills.
Advantages of T-Bills
A safer and conservative investment with virtually no default risk since they are backed by the US Government
Accessible for new traders with a low minimum investment of only $100
Income earned from interest is exempt from state and local income taxes (this income is still subject to federal taxes!)
Can be purchased directly from the government or easily bought through an intermediary on the secondary bond market
Disadvantages of T-Bills
Lower yields and returns in comparison with other debt instruments and higher-yielding investments
Investors have to wait for the bill to reach maturity to receive any interest
Tie up funds until the maturity date or sale/transfer of the bill
Have a set interest yield and a risk of falling below prevailing interest rates
FAQ about Treasury Bills (T-Bills)
Q1: What’s the difference between money market funds and Treasury Bills?
Money market funds offer high liquidity and can potentially accumulate interest faster than some other investment methods, with investment options ranging from $1 to $1 million. They are also insured by the Securities Investor Protection Corporation (SIPC).
However, it's important to note that while these funds are typically considered low-risk, they are not entirely without risk. Market volatility can still affect the value of these funds. Additionally, while SIPC protection covers the custody function of the broker dealer, in case it fails, this coverage does not protect against losses arising from market fluctuations or a decline in the value of your investments.
Treasury Bills have lower liquidity, only pay interest at the maturity date, are sold in increments of $100, from $100 to $10 million or 35% of offering amount, and are both SIPC insured and backed with full faith of the US Government.
Q2: Is it safe to put money in Treasury Bills?
Treasury Bills are backed by the full faith and credit of the US Government, so there is extremely low default risk.
Q3: If I have a Treasury Bill, what type of interest payments can I expect to receive?
You will only receive an interest payment when the bill reaches its maturity date. In late 2023, an average T-Bill interest rate was around 5%.
Sources:
1. Auction Search (Query) — TreasuryDirect Yield is an annualized 26-week T-bill rate (as of 12/18/23) when held to maturity.