T-bills or treasury bills are short-term securities issued by the federal government. They’re categorized as a short-term security because they have a short maturity date-when the investor receives the face value of their investment back.
When you buy T-bills, you’re borrowing the government money to pay debt and finance public projects. Seeing as T-bills are backed by the U.S. government, they’re considered zero-risk and one of the safest investments. They’re also an accessible investment considering a T-bill can be bought with $100.
The Ins And Outs of T-Bills
Investors can buy T-Bills through TreasuryDirect, a bank or their broker. The only type of bills they may not get on TreasuryDirect are cash management bills.
When issued, treasury bills have a pre-determined face value, which could be anything from $100 to $5,000 or $10,000. The bills are sold in increments of $100 and the minimum amount you can buy is $100.
Profiting From T-Bill Discounts
T-bills are usually sold at a discounted price from the face value. So that means if the face value of a T-bill is $5,000, an investor may purchase it for a discounted price of $4,800. The discount rate-the difference between the face value and discounted purchase price–of most T-bills is determined at a weekly public auction held by the U.S. treasury. Other factors can impact the discount price of a T-bill such as the federal funds rate, demand, and inflation.
The discount rate is how investors profit from T-bills as it creates a form of “interest”, which is the difference between the face value and discounted purchase price of a T-bill.
As an example of how discount rates work, if a 52-week T-bill had a face value of $1000 and a discount rate of 3.5%, it may be sold to an investor at a discounted price of $975. When the T-bill matures, the investor would get $1,000, earning “interest” of $35 thanks to the discount. Maturity dates on T-bills are usually 4, 8, 13, 17, 26, or 52 weeks.
Interest for T-bills is usually paid once the security matures. This is contrary to bonds and notes where you may receive interest every six months.
Selling T-Bills Before Maturity
An investor also has the freedom to sell a T-bill before the maturity date to realize profit. By selling a T-bill before its maturity date, investors may profit from their interest gains by reselling the security on the secondary market.
While the investor won’t be charged fees for selling the t-bill before it matures, they will forfeit some interest.
Whether an investor sells a T-bill or waits for it to mature, federal taxes must be paid on the interest earned. Those gains are typically reported on form 1099-INT and investors are taxed at their income tax rate. The silver lining is taxes end at the federal level since investors are exempt from paying state and local taxes. The tax exemptions on T-bills in addition to low risk can make them attractive to investors.
Pros and Cons of T-Bills
T-bills can be a form of passive and steady income. They can also add some balance to your portfolio when the stock market is volatile. However, these short-term securities aren’t ideal for investors looking to get a high rate of return. Stocks or corporate bonds might be a better investment for investors looking for higher returns.
Here is a quick breakdown of the pros and cons of T-bills.
Pros
- No state or local tax
- Zero-risk investment
- Can provide stable income
- Can buy and sell on secondary market
Cons
- Rising interest rates can make them less valuable
- Lower returns relative to other securities like Certificate of Deposit
- No incremental interest payments
If you’re unsure about whether T-bills are a good investment to add to your portfolio, reach out to one of our financial professionals today. There are also T-Bill calculators online that can be used to estimate potential returns if you want to run the numbers before moving forward.
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