Monday, December 11, 2006

Investing in Treasury Bills

I'm as patriotic as the next guy, but one thing I don't like doing is paying the government more of my money than I have to. This was part of the reason why I first got interested in investing in treasury bills - they are tax free at the state and local level.

What are treasury bills?

When the US government wants to borrow money for a short period of time, it does so by issuing short-term debt instruments called treasury bills. A lender (which could be you!) pays the government some money and 3, 6 or 12 months later the government pays that money back, with interest.

Unlike a regular bond or savings account, you don't receive interest on your treasury bills until they mature. This is similar to a zero coupon bond. A simplified example to illustrate this with numbers- let's say 1-year treasury bills are yielding 5%. You could buy a $10,000 treasury bill for $9,500 (a discount), and one year from now, you would receive $10,000 back from the US Treasury, $9,500 which is the return of your principal, and $500 of which is your interest ($10,000 * 5%).

Why invest in treasury bills?

There are three reasons why I invest in treasury bills - yield, safety, and the fact that interest on treasuries is tax-free at the state and local level.

The yield on treasury bills has fluctuated over time, just like all interest rates have. In recent times, the yield on the 13-week T-bill (commonly referred to as the "3 month" or "90 day" T-bill) bottomed out around .8% in June of 2003, following the federal reserve's unprescedented rate cuts during that time period. However, we have had some rate hikes since then, and the yield has climbed to around 4.8% more recently. Compare that with yields on similar short term vehicles such as money market accounts and CDs and you'll see it is in the ballpark, and definitely more than you would earn in most bank savings accounts.

Treasury bills are considered the safest financial instrument you can invest in. In fact, many analysts refer to the T-Bill yield as the "risk-free rate" because it is the closest thing to a sure return an investor can get in today's world. The thinking here is that the US Government is a rock-solid creditor- the treasury can just print more money if it doesn't have enough to pay you back.

How to Invest

Unlike corporate bonds, treasury bills/bonds are very easy for the average investor to get into. All you have to do is go to and open up a personal account.

I've had an account on this site for about 9 months now, and though I will say there is a bit of a learning curve at first, I have gotten used to the way the T-bill market works. I'll give you a runthrough of one trade I did a few months ago to show you a little bit about how the process works.

On Tuesday December 12, I decided to take $10,000 from my ING direct account and invest it into a 26-week (6 month) treasury bill. This is part of my down payment fund, so i knew I wouldn't need it for at least 6 months. At that time, 6 month bills were yielding somewhere around 4.8% vs. my ING Direct account yielding 4.6%.

Treasury bills are sold via auction, and according to TreasuryDirect, 6-month treasury bills are auctioned every Thursday. The way this process works is basically a bunch of big institutional buyers (called competitive bidders) put in bids to buy treasury bills, and the Treasury awards them all at the one highest rate needed to sell all of the securities. The smaller buyers like you and me (called noncompetitive bidders) receive the securities at that rate without having to do anything.

So, I put in my $10,000 order on Tuesday.

When Thursday December 7 came around, I checked my account and saw that the security was issued to me. I paid $9,755.31 for the 6 month treasury, and I will get back $10,000 on June 7, 2007. This nets me $244.69 in interest over 6 months, which works out to a 4.84% yield (vs. the 4.5% APR I was earning at ING Direct).

I headed over to my ING Direct account and saw that the funds had been taken out.

When tax time comes around next year, I won't have to pay taxes on this interest on my NY State and City filing. Assuming my tax rate is about 22%, this results in me keeping $53.83 of the $244.69 that I otherwise would have been paying to New York!

In Summary

Treasury bills should be another tool in your short-term investing toolkit. Sometimes it makes sense to invest in treasury bills, but you have to compare their yield, as well as the tax benefits, to your alternatives. As with any investment option, be sure to do your research before putting your money to work for you!

(note: this is not to be construed as investment or tax advice, it is just my own experience)

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