What is a Treasury Bill?

July 27, 2023
10 MIN READ
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A treasury bill or T-bill is an instrument of debt issued by the U.S. government. They are considered to be short-term investments and can reach maturity in as little as 4 weeks. T-bills can be purchased by anyone from everyday citizens to billion-dollar corporations. They are typically sold in denominations of $1,000, and buyers can purchase as many as $10 million of them at a time. Because T-bills have the full faith and backing of the U.S. government, they are considered by many to be one of the safest investments available since the U.S. has never defaulted on its debt obligations.

How Do Treasury Bills Work?

Among the many ways that the U.S. Treasury can raise the capital it needs, a commonly used alternative is to sell T-bills. A T-bill is essentially a zero-coupon short-term bond. This means that difference between the purchase price and the par amount (i.e., the amount you'll receive at maturity) is simply the interest rate it was assigned.

Maturity Terms

T-bills can be purchased with the following maturity terms:

●       4 weeks

●       8 weeks

●       13 weeks

●       17 weeks

●       26 weeks

●       52 weeks

Interest is paid once the T-bill reaches maturity. Investors who wish to cash out early must sell their T-bills on the secondary market.

Interest Rates

Because of their short-term nature, the interest rates of T-bills generally follow the federal funds rate set by the U.S. Federal Reserve. Each time the Fed meets and sets a new target rate range, T-bills are issued at the new interest level in order to make them competitive with other investment opportunities.

In regular times of economic prosperity, longer-term T-bills will pay a greater interest rate. However, this trend can sometimes be reversed if it's expected that the Fed will lower interest rates.

As with other interest-yielding assets, T-bills are also subject to other market influences such as market risk and inflation. For instance, if the owner of a T-bill wishes to sell it on the secondary market, then they might have to do so at a discount since newly issued T-bills could be available with better interest rates.

T-Bills and Taxes

T-bills do provide some tax advantages over other interest-bearing investments. They are subject to federal taxes but are exempt from state and city taxes.

Similar to other assets with interest income, owners will receive tax form 1099-INT if they’ve earned more than $10 in interest. This information can be used to prepare your federal income tax return.

Buying a T-Bill Example

Let’s assume you’d like to invest $1,000 in a T-bill, and the current interest rate for a 52-week T-bill is 5.0%.

The first thing to note is that the T-bill would not cost $1,000. T-bills are sold at a discount meaning that the purchase price is less than the par value (i.e., face value). Therefore, since the par value would be $1,000, the cost for this T-bill would be:

●       Par value = $1,000

●       Interest rate = 5.0% or $50

●       Purchase price = $1,000 - $50 = $950

T-bill interest rates are always given in terms of an APR (annual percentage rate) regardless of the maturity term. This is a commonly used practice throughout finance because it helps investors a means to quickly make comparisons between two investment options. However, this can result in a different interest payout than you may expect.

For example, suppose instead of a 52-week T-bill you had purchased a 26-week T-bill that also carried a 5.0% APR. In this case, instead of receiving $50 in interest, you’d only receive $25 (since 26 weeks is half of 52 weeks). As a result, the purchase price of a $1,000 T-bill would then be $1,000 - $25 = $975.

Are Treasury Bills Good Investments?

Depending on your investment goals, T-bills can make an excellent addition to your portfolio. However, this will generally be conditional on the importance of the following criteria:

Interest Rates

In a high-interest rate environment, T-bills can provide a virtually risk-free high yield that’s greater than the rates you may see advertised on the average bank savings account. However, T-bills may not be as attractive as the yields offered by bank CDs (certificates of deposit) or some bonds.

Conversely, when interest rates are low, T-bills may appear less attractive. For example, during the 2010s, T-bills paid close to 0%. Investors seeking conservative and even medium-risk assets would find better-yielding alternatives.

Liquidity

T-bills must be held until maturity before you can receive an interest payment. However, because the maturity terms are so short, they can offer better liquidity than most CDs and bonds.

Additionally, investors can structure a T-bill ladder where they strategically purchase a series of bills with varying maturity dates and interest rates. This creates a revolving system of available capital and interest income.

Asset Allocation

If you’re risk averse, then T-bills could serve an important role in your portfolio. For instance, a retiree who wants to produce a steady income and doesn’t want to be subject to market fluctuations might allocate a portion of his assets to T-bills.

However, a younger investor who is still decades away from retirement may not want to devote much of their portfolio to T-bills. They would be better off opting for more aggressive assets such as stocks and ETFs (exchange-traded funds).

Taxes

Because of the tax advantages that T-bills can offer, it's generally not recommended that they be held in a retirement account such as a Roth IRA. Similar to the tax incentives that come with capital gains and dividends, they can make a good alternative to other forms of interest income (like high-yield savings accounts or bank CDs).

How Do You Buy T-Bills?

T-bills can be added to your portfolio using a variety of different methods.

Treasury Direct

The most straightforward way to buy T-bills is to get them directly from the U.S. Treasury. This can be done by setting up a Treasury Direct account. Note that all T-bills are sold digitally and paper copies are no longer issued.

Technically, T-bills are auctioned rather than sold. This is done in order to make them more attractive to large financial institutions and corporations resulting in the sale of a greater quantity of bills. Auctions are only held every four weeks, so investors must wait until the next event to participate.

Because of their financial backing, only banks and large financial institutions can purchase T-bills at discounted auction prices. Ordinary investors will make non-competitive bids which generally result in the full asking price set by the U.S. Treasury.

Brokerage

Just like buying stocks or mutual funds, investors can also purchase T-bills through their brokerage accounts (such as Vanguard or Fidelity). This can be a convenience for investors who don’t want to have multiple accounts and would like one tax form at the end of the year. However, there will be some fees involved and it does create some limitations on which T-bill maturities you can choose from.

ETFs

Another way to own T-bills without buying them directly is to own an ETF that invests in them for you. This method gives you the best liquidity because the ETF can be traded at any time without consequence. However, the yield you’ll receive won’t be as great as what you’d get by owning the T-bill directly because of ETF fees and administrative costs.

The Bottom Line

Treasury bills are short-term debt instruments that pay competitive interest rates. They are issued by the U.S. Treasury and are considered to be virtually risk-free.

Investors may consider adding T-bills to their portfolios if they want modest yields, liquidity, and safety. They can be purchased directly from the Treasury, through their brokerage, or as part of an ETF.