What are Treasury Bills and How to Buy Them?

Introduction

Treasury bills are often considered the foundation of many investment portfolios owing to their security and guaranteed returns. These short-term debt securities are released by the U.S. Department of the Treasury as a way of increasing capital and gaining steady profits safely. They are viewed as having almost no risk, due to the backing of the United States government.

 In today’s dynamic financial conditions, T-bills offer more than just safety; they aid in reducing portfolio risks. With a short-term maturity period of one year or less, these instruments can be easily adjusted to market fluctuations, enabling investors to seize new opportunities. 

In this guide, we will explain how treasury bills work, how to buy them, and their advantages and risks.

What are Treasury Bills (T-Bills)?

Treasury bills are short-term debt securities issued by the U.S. Department of the Treasury to raise government fund requirements that typically mature in a year or less. Their term usually ranges from 4 to 52 weeks. While they may not offer the highest returns, they are considered a low-risk investment as they are backed by the government. 

How do Treasury Bills Work?

T-bills work differently than longer-term fixed-income investments, which pay interest semiannually until maturity. You buy T-bills at a discount from the face value — known as the price before par. Your interest is the difference between the discounted price and the par value at maturity.

To understand T-bills let us take an example, say you lend $100 to a friend, and they promise to pay you back $105 in 6 months. That’s essentially how T-bills work. Investors lend money to the government by purchasing T-bills at a discount to their face value. When the T-bill matures, the government pays back the face value, allowing investors to pocket the difference as interest.

Interest earned from T-bills can be calculated as follows:

Example of a T-bill

Let’s say you buy a 1-year T-bill with a face value of $1,000 for $950. After one year, the government pays you back the full $1,000. Your earnings are the difference between what you paid ($950) and what you received ($1,000), which is $50.

Redemptions and Interest on Treasury Bills

When you invest in Treasury bills (T-Bills), you’re essentially lending money to the U.S. government. Unlike traditional bonds that pay periodic interest, T-bBills are sold at a discount to their face value and do not make interest payments throughout their term. Instead, investors earn interest by purchasing T-bBills at a discounted price and receiving their full face value at maturity.

Let’s break down how this works:

1. Discounted Purchase: When you buy a T-bBill, you pay less than its face value. For example, you might purchase a $1,000 T-bBill for $950. This $50 difference represents your earnings, or interest, on the investment.
2. Face Value Redemption: At maturity, the U.S. government pays you the full face value of the T-bBill. Using our example, you would receive $1,000 when the T-bBill matures.
3. Effective Interest Rate: The effective interest rate you earn on a T-bBill is determined by the difference between the purchase price and the face value, relative to the time until maturity. It’s a simple yet effective way to earn a return on your investment without the complexity of regular interest payments.

T-Bills are an attractive option for investors seeking safety and simplicity in their portfolios. While they may not offer the highest returns compared to other investments, their predictable nature and government backing make them a valuable tool for preserving capital and managing risk.

How To Buy Treasury Bills?

Buying T-bills is straightforward. Investors can purchase them directly from the U.S. Department of the Treasury through their online platform, TreasuryDirect. Setting up an account is free. You can select the desired T-bill and specify the amount to invest. The amount you can buy T-bills in increments as low as $100. 

Here’s a step-by-step guide to doing so.

Opening an Account: Before purchasing T-bills, you need to have an account with a bank or a brokerage firm that participates in Treasury auctions. This account will be used to hold your T-bills.

Decide on the Type of T-bill: Treasury bills come in different maturities, typically ranging from 4 weeks to 52 weeks (1 year). You’ll need to decide which maturity suits your financial goals, whether short-term or medium-term.

Auction Participation: Treasury bills are sold at auction by the U.S. Department of the Treasury regularly.

Bid Submission: Your bid will include the bid amount (usually in increments of $100) and the discount rate you are willing to accept. The discount rate is the annualized interest rate you will earn if you hold the T-bill until maturity.

Auction Results: After the auction closes, the Treasury announces the results.

Payment and Settlement: On the settlement date (usually the next business day after the auction), the funds for your T-bill purchase will be debited from your account.

Hold or Sell: Once you own T-bills, you have the option to hold them until maturity to receive the full face value (with the difference between the purchase price and face value being your interest), or you can sell them on the secondary market before maturity.

Pros and Cons of Treasury Bills

Treasury bills are safe as they are issued by the U. S government. Their risk levels are low because they are easily predictable and are mostly short-term investments. However, they usually have lower return rates as compared to other securities, such as equities. 

Also, they do not always have inflation-adjusted returns that may reduce the purchasing power over time, which is a risk to investors.

Pros of T-bills

1. Safety: Backed by the U.S. government, T-bills are considered one of the safest investments.
2. Liquidity: T-bills are highly liquid, meaning you can sell them easily if you need cash.
3. Predictable returns: Since T-bills have fixed maturity dates and interest rates, your returns are predictable.

Cons of T-Bills

1. Lower returns: While T-bills are safe, their returns are generally lower compared to other investments like stocks or corporate bonds.
2. Inflation risk: The returns on T-bills may not keep pace with inflation, potentially eroding your purchasing power over time.

Federal Reserve Policy for T-Bills

The Federal Reserve uses T-bills as a tool to implement monetary policy, primarily through open market operations. By buying or selling T-bills, the Fed can influence short-term interest rates to achieve its monetary policy objectives.

The Federal Reserve influences Treasury bills (T-bills) through:

1. Interest Rates: By setting the federal funds rate, the Fed directly impacts T-bill yields. Higher rates mean higher T-bill yields and vice versa.
2. Quantitative Easing: The Fed’s purchases of T-bills can lower yields by increasing demand for these securities.
3. Forward Guidance: Statements about future rate intentions affect market expectations and T-bill yields.

The Bottom Line

Treasury bills are the foundation of many investment portfolios due to their safety and liquidity. Businesses can identify their idle cash and utilize the opportunity to invest in T-bills to gain better returns. While they may not offer the highest returns, their stability and predictability make them a valuable asset for investors seeking to preserve capital and manage risk. With TreasuryDirect making them easily accessible, T-bills are worth considering for anyone looking to diversify their investments and protect their financial future. 

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FAQs

1. Can you lose money on treasury bills?

Yes, selling treasury bills before maturity at a price lower than your purchase price can lead to losses. This typically occurs if market interest rates rise, reducing the value of the T-bill in the secondary market. Investors may receive less than the original investment, depending on prevailing market conditions at the time of sale.

2. Are treasury bills taxable?

Yes, treasury bills are subject to federal taxes on the interest earned. However, they are exempt from state and local taxes, making them more tax-efficient investments. The interest earned on the T-bill is taxed as ordinary income at the federal level, impacting the overall return on investment for taxpayers.

3. Where to buy treasury bills?

T-Bills can be purchased directly from the U.S. Treasury Department through their online platform, TreasuryDirect. Investors can also buy them through a brokerage firm or financial institution. It offers a user-friendly interface for individuals to buy, manage, and redeem T-bills.

4. Are treasury bills a good investment?

Yes, T-bills are often considered a good investment, especially for conservative investors seeking safety and stability. T-bills offer predictable returns and are highly liquid. While they may not offer the highest returns, their reliability and low risk make them a valuable addition to diversified portfolios.

5. Are treasury bills taxed as capital gains?

No, treasury bills are not taxed as capital gains. Instead, the interest earned on treasury bills is taxed as ordinary income at the federal level. This means investors are taxed based on the difference between the purchase price and the face value of the T-bill at maturity, according to their income tax bracket.

6. How to calculate the yield rate of T-bills?

To calculate the yield rate of treasury bills, use the formula: Yield = (Face Value – Purchase Price) / Purchase Price * (365 / Days to Maturity). This formula considers the discount at which T-bills are purchased and the time until maturity to determine the annualized rate of return.

7. What are the benefits of treasury bills?

Treasury bills offer benefits such as safety, liquidity, and simplicity. They are backed by the government, ensuring minimal risk. T-bills are highly liquid, easily tradable investments, making them suitable for short-term cash management and preserving capital.