Treasury Bills (T-Bills) – What They Are & How to Buy for Investment

One reason many savers delay or completely avoid investing is the fact that investing comes with risk. They realize that while money can be made in the market, it can also be lost.

That’s a scary notion for most. After all, if you’re like most Americans, you’ll work at least 40 hours every week for most of your adult life. You don’t want to work that hard to earn money you’re just going to lose in the end.

Whether you’ve let fear of loss keep you away from setting up a nest egg for your future or you are nearing retirement and can’t stomach the ups and downs of the stock market, treasury bills offer an attractive investment opportunity.

Treasury bills, commonly called T-bills, are a great way to set the foundation for your financial future and put your hard-earned dollars to work for you.

What Are Treasury Bills?

T-bills are short-term fixed-income debt securities that are widely considered one of the safest investments anyone can make. That’s because these investments are backed by the full faith and security of the United States government.

Issued by the U.S. Department of the Treasury, T-bills are offered by one of the strongest and wealthiest entities in the world.

Like other debt instruments issued by the U.S. Treasury, T-bills are considered a safe-haven investment, known for producing reliable returns even in times of economic declines.

However, unlike other offerings by the Treasury, they offer very short terms, greatly reducing the interest-rate risk associated with investing in fixed-income securities.

T-bills mature in less than one year, whereas investments in Treasury notes mature in one to 10 years and investments in Treasury bonds typically take 30 years to mature.

Another way these bills differ from Treasury bonds and notes has to do with how investors earn money from them because they don’t pay interest.

How Investors Earn Money Investing in T-Bills

While most fixed-income securities like bonds pay interest in the form of coupon rates, there is no interest offered when investing in T-bills. When a T-bill matures, investors receive the full face value of the bill, often referred to as the par value — not a penny less or more.

So, where do the profits come in?

The Treasury auctions T-bills to investors, who purchase the security at a discount to the face value.

For example, an investor may purchase a bill with a $1,000 face value and a six-month maturity at a price of $950. In six months, when the investment matures, the investor receives $1,000, producing $50 in profit.

This is attractive because it gives investors a fixed rate of return. You’ll know exactly what to expect when your investment matures, without having to rely on interest payments or subjecting yourself to interest-related risks.

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How Are Treasury Bills Priced?

There are two different ways these bills are priced, known as competitive bidding and noncompetitive bids. Here’s how they work:

Competitive Bidding

Every week, the Treasury holds an electronic auction surrounding the price of bills for that week. Both institutional and retail investors are invited to take part in the auction.

During the auction process, investors place bids for both the quantity of bills they’re willing to buy and the rate at which they’re willing to buy them. Of course, the best bid that gives the Treasury the best deal will be accepted.

Importantly, unlike noncompetitive bidders, competitive bidders are not guaranteed any bills at the end. In order to purchase bills using the competitive bidding method, you must win the auction for the issue you’re interested in.

Although anyone is welcome to take part in the competitive bidding process, the vast majority of bidders are large investors, including institutions and high net worth individuals.

Noncompetitive Bidding

Negotiating terms through a competitive bidding process is a great way for the Treasury to make sure it gets the best deal on the securities it issues. Then again, the Treasury issues trillions of dollars in securities every year, and trying to track an auction for each block of T-bills is a cumbersome process.

To streamline the process and get its hands on the funding it needs through the securities market, the Treasury also offers noncompetitive bidding.

Bills and other Treasury securities that are sold based on a noncompetitive bid are priced based on the average of all competitive bids, which provides several advantages. The most significant benefits include:

No Brokerage Fees. Competitive retail bidders need to make their bids through a broker. This adds fees to the process, eating into your returns. On the other hand, you can purchase bills through a noncompetitive bidding process directly through the Treasury on the TreasuryDirect website, cutting out middleman costs.
Fair Price. Because the price on noncompetitive bills is based on the competitive bids offered by institutional and high net worth investors, retail investors who purchase T-bills through TreasuryDirect will get a fair price on their investment.
Guaranteed Fill. When making competitive bids, your order will only be filled if your bid is the best. By contrast, all securities you purchase in a noncompetitive bidding environment will end with filled orders.

What Are You Funding When You Buy Treasury Bills?

Investors are beginning to realize their investing dollars aren’t just working to earn them money. In many cases, investors can make a socioeconomic and environmental impact by putting money in the right places. These days, many investors want to know where their money is going when they make an investment.

When investing in bills from the Treasury, your money will be used for the following:

Building Schools. Funding raised through the sale of bills often is used to build schools, learning centers, and other facilities designed to educate and prepare children and young adults for a prosperous future.
Highways. Have you ever been stuck in a road work-related gridlock on your way home? Although road work can be an annoyance, it’s also necessary to ensure the roads and bridges you travel on are safe. Maintenance work on public infrastructures like interstate highways and bridges is often funded through the sale of Treasury securities.
Cash Management. Balancing your checkbook at home may be a bit of work from time to time, but imagine balancing the checkbook at the Treasury. The amount of cash that flows in and out of the Treasury is mind-boggling, and sometimes the Treasury may need to raise funds just to balance its books. In these cases, cash management bills are sold in order to provide the balance needed.
Other Government Projects. The government funds a long list of construction, education, health, and other projects. Investments in Treasury securities like bills, bonds, and notes fund a large portion of these projects.

How to Buy T-Bills

There are two ways to get your hands on these highly secure investments:

Through Your Broker. There are several brokers, such as TD Ameritrade, that offer exposure to Treasury bills and other government-backed securities. Although you pay brokerage fees in the vast majority of cases when buying these bills through your broker, the fees may be worth it if you get good deals through competitive bids.
Through TreasuryDirect. Although buying through your broker may seem like a great way to go, the majority of individual investors will be better served by purchasing their bills from the source on the TreasuryDirect website. As mentioned above, doing so all but guarantees a fair price, ensures your order will be filled, and provides a workaround to expensive broker fees.

What Causes Price Fluctuations in T-Bills?

As with any other financial instrument, the price of bills issued by the Treasury and on the secondary market will fluctuate depending on a range of factors. Some of the most significant factors include:

Federal Reserve

The Federal Reserve is charged with keeping a balance in the U.S. monetary system. One way it does this is by raising and decreasing the federal funds rate, or the interest rate banks charge one another when lending money back and forth from reserve balances overnight.

When the fed funds rate is low, money flows more through the banking system, making loans easier to come by and generally leading to an expansion in economic activity.

On the other hand, when the fed funds rate is high, banks have less money to land, which could lead to a contraction in economic activity.

Both of these will have an impact on the Treasury’s debt securities, especially T-bills. When rates are low, bills offer a great store of value for the safe-haven allocation within your portfolio. However, when rates are high, investors tend to sell these bills in search of higher yields from other options.

Inflation

Inflation is an important economic factor that all investors should pay attention to, whether investing in bills, stocks, or any other asset. Inflation is the rate at which prices rise. In some cases, inflation rates can rise to be higher than the rate you’ll be paid on these bills.

The net result when the bill’s return can’t keep up with the rising cost of goods is a loss. As a result, when inflation rates are high, investors tend to avoid T-bills.

Conversely, when inflation rates are low, investors look to these bills as a safe store of value, because low inflation rates generally equate to bearish market activity.

Market Conditions

Market conditions play a major role in the movement seen in any safe-haven investment. Safe havens are known to be strong stores of value but aren’t great growth opportunities. Instead, their values rise at a slow, steady rate.

When the stock market is on a bull run or a strong trend in the upward direction, safe havens like T-bills become less attractive. Why would you want to earn less than 2% annualized returns when the market is on a tear upward, often generating that or more in a week?

On the other hand, when the market makes a run for the bottom, whether caused by economic and geopolitical uncertainties or a widespread belief that market bubbles are creating unreasonable valuations, bills and other securities issued by the U.S. Treasury become more attractive. They guarantee growth in value even during bear markets.

Maturity Dates

As with any fixed-income security, maturity dates play an important role in the price of T-bills.

Holding fixed-income investments for longer periods of time increases interest-rate risk — the risk that better opportunities will become available while your money is tied up. In general, the farther out a maturity date is, the larger the return will be.

For T-bills, which provide a premium on the purchase price rather than interest payments, longer maturity bills come at a lower purchase price, offering a higher return.

Pros and Cons of Treasury Bills

No matter how you choose to invest, there will be benefits and drawbacks associated with your choice. When it comes to bills issued by the U.S. Treasury, the most significant pros and cons include:

T-Bill Pros

The fact that trillions of dollars of T-bills are issued every year suggests there must be benefits to getting involved in them. Investors like T-bills as an investment option because they:

Risk-Free. Investments in these bills are so low risk, they’re often considered to be risk-free. That’s because these bills aren’t backed by some company, or even a local municipality, but by the full faith and credit of the U.S. federal government.
Short Lifespan. The lifespan of these bills is incredibly short, ranging from a few weeks to a year, but never longer. Because these bills come with shorter maturities than other income-focused securities, interest-rate risk is greatly reduced.
Reliable. When you buy one of these bills, you know its par value and the amount you’re paying to purchase it. As a result, before the investment is ever made, you’ll know exactly how much money you’ll make once the investment matures. There’s peace of mind in knowing exactly how your investments will turn out.

T-Bill Cons

Sure, these bills offer some excellent perks, but every investment comes with a drawback, with risk or reduced returns just about always being in the equation. Here are the downsides to investing in T-bills:

Low Returns. Most income-focused securities come with low returns. That’s because these are generally safe investments, and where there’s minimal risk, there’s often minimal potential for meaningful returns. That proves to be the case with T-bills, as they provide some of the lowest returns of securities of any class.
Lower Liquidity. When changes in the fed funds rate, market conditions, inflation, or a mix of the three take place, the potential value of a Treasury bill can become unattractive quickly. However, selling these bills may be difficult as investors look toward other opportunities with their investing dollars.
Inflation Risk. In both 2017 and 2018, the U.S. inflation rate clocked in at over 2%. The average return rate on T-bills is generally below this mark. As a result, investments in these bills during these years would have generated a net loss. Although the dollar value of the investments grew, the purchasing power of those dollars shrank at a faster rate.

How Are Returns Taxed?

Successful investing ultimately results in income, whether through price appreciation, dividends, interest, or premiums. This income will eventually be taxed. When making any investment, it’s important to consider the tax implications.

Investing in bills issued by the U.S. government comes with some tax perks. For instance, gains from these investments are not subject to state or local income tax.

At the end of the year, you’ll be provided with a form 1099-INT, detailing the interest paid throughout the year. This income will then be taxed at the federal income tax rate.

It’s important to keep in mind that although T-bills enjoy local and state tax benefits, the fact that gains are taxed at your federal income tax rate — rather than the capital gains rate — means your tax burden on these investments will be higher than on investments held for more than one year.

Final Word

If you’re looking for a safe way to make your first investment, an option to protect your money during bear markets, or a safe-haven asset to balance out a portfolio with riskier assets, Treasury bills just might be the way to go.

Due to the short-term nature of these securities, and the fact that they’re backed by the full faith and confidence of the U.S government, there aren’t any other investments on the market that provide the level of safety that these investments provide.

On the other hand, if you’re looking to produce significant gains and are willing to accept the risk that comes along with doing so, you’ll be better served elsewhere.

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