Treasury bills — better known as T-bills — are debt securities issued by the United States Treasury with maturities of one year or less. They are considered risk-free, as the government can always print the money to pay back the debt. And given that they have only a short time to maturity, they have very little sensitivity to interest rate moves. If interest rates rise, the bonds don’t fall much in value.
For the first time in the investment lives of many Americans, T-bills have been offering a competitive yield. At the time of writing, T-bills offer yields at an annualized 4+% depending on the specific time to maturity.
You may be one of those Americans buying T-bills for the first time. And if so, let’s walk through the process of what happens when your T-bill matures and what your options are.
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How do Treasury bills work?
True T-bills generally do not make interest payments (called “coupon payments” in bond parlance). Instead, you buy them at a discount. In a hypothetical example, you might pay $950 today for a T-bill that will mature at $1,000, netting you a risk-free profit of $50.
You can also buy longer-term Treasury notes that are close to maturity and get the same effect. For example, a 10-year Treasury Note that is already nine years old and has one year remaining will have the same basic characteristics, though a portion of your return will come from semiannual coupon payments.
When your T-bill matures, its life is over. The U.S. government will pay you the full face value of the bond. In our example above, you’d simply see the bond disappear out of your brokerage account or IRA and be replaced with $1,000.
What do you do after a Treasury bill matures?
T-bills might be risk-free in terms of credit risk and virtually risk-free in terms of interest rate risk, but they do present the “high-quality” problem of reinvestment risk.
Reinvestment risk is the possibility that your investment options might not be as attractive when your bill matures and you have the fresh cash to deploy. Today, T-bills pay a little under 4.5%. In six months, it’s entirely possible yields will be significantly lower than that.
Reinvestment risk should be a factor you take into consideration when choosing what specific security to buy. Today, at time of writing, four-week T-bills offer a yield of 4.54%. But a T-bill with a year to maturity yields about 4.42%.
Do you chase that higher yield on the shorter-term bill knowing that you might have to reinvest the proceeds when it matures at a lower rate? Or do you lock in a slightly lower yield to eliminate that risk?
“The best solution for minimizing reinvestment risk is simply to split the difference and ladder your fixed income portfolio,” said Douglas Robinson, a bond trader and principal of RCM Robinson Capital Management LLC in Mill Valley, California. “As a practical matter, this would mean dividing your investment in T-bills into several smaller investments, each maturing on a different date.”
If you’re investing a modest amount, laddering might not be super practical. But if you have a large chunk of your net worth invested in T-bills, laddering can be a good way to guarantee a decent yield while also giving you the ability to quickly reinvest as opportunities present themselves.
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