The Reasoning to Invest in Short Term Treasury Bills
I recently purchased short term (~1 month maturity) Treasury Bills after reading this article posted by Ray Dalio. Treasury Bills are unique because they are considered “risk-free” since there is no risk of losing your principal because the debt is backed by the US Government which in collaboration with the Federal Reserve can print more money so would not default on the debt. Treasury Bills also are not taxed at the local and state level and only at the Federal level.
The Thinking Behind Why Cash Is Now Good (and not Trash)
My comments over the last couple of months that “cash is good”— which was opposite to my comment made in early 2020 that “cash is trash” — got a lot of attention prompting some people to want to know why I changed my mind. To be clear, what I tried to convey both times is how attractive cash is base
Dalio explains his reasoning behind “Cash is Trash” in 2020 when rates offered were less than 1 percent. Now short term rates are up to around 5.5% recently. In this article I will share my thinking on Dalio’s article and also the practical step by step approach of purchasing Treasury Bills in your Wells Fargo trading account. I assume the process will be relatively similar with other banks.
As you can see below short term rates have risen a lot recently and currently as of Oct 3rd, 2023 they are at ~5.32%, this higher than what they got to in February 2007 before the real estate bubble burst.
If you have savings sitting in a checkings account now would be a great time to shift that into short term Treasury Securities. The rate of interest for a savings account at Wells Fargo for me is 0.01% so instead of letting the bank collect the spread between 5.35% and 0.01% I prefer to keep that for myself.
What is the difference between a Treasury Bill and a Treasury Bond?
Treasury bills are short term government investments that mature within 4 weeks to 1 year and usually pay less interest than Treasury Bonds which have a maturity greater than 10 years and usually pay a higher rate of interest than Treasury bills because of the longer maturity. Normally the longer you have your money tied up the greater return you should expect for that. Treasury notes mature anywhere between two and 10 years, with bi-annual payments.
Understanding the Yield Curve Inversion:
The yield curve, a graphical representation of the interest rates on debt for a range of maturities, has historically been a reliable predictor of economic recessions. When the curve inverts, it means short-term interest rates exceed long-term rates. As of July 2022, the yield curve inverted, and historically, every recession since 1957 has been heralded by such an inversion. The time lag between the inversion and the onset of a recession has ranged from 8 to 19 months, averaging around 13 months. The inversion suggests that investors anticipate current economic growth to outpace future growth, signaling an impending recession. The yield curve went inverted in July 2022 and it is not Oct 3rd, 2023 which is about 14.5 months later.
This FRED graph effectively illustrates that every recession since 1957 has been preceded by a yield curve inversion.
The Rationale for Investing in Short-Term Treasury Bills: Investing is all about timing and valuation. Like any asset, cash and bonds can be undervalued or overvalued. To discern the current valuation of these assets, consider the following:
- Real Interest Rates: Examine interest rates in relation to expected inflation. The real interest rate is the difference between the two.
- Federal Reserve's Stance: The FED adjusts rates based on inflation and growth. If both are high, expect a rate hike. Conversely, if they're low, anticipate a rate cut.
- Expected Returns: Compare the expected return from cash to other investments.
- Supply and Demand Dynamics: Understand the current market demand for cash and bonds.
When to Invest in Cash: Consider lending in cash when:
- Interest rates are on the rise, and the risk-free rate exceeds the inflation rate by more than 1%. The larger the gap, the more favorable it is to lend.
- The real interest rate matches or surpasses the economy's growth rate. In simpler terms, when the interest rate exceeds the sum of inflation and real growth.
The Case Against Long-Term Bonds in a Low-Interest Environment: In 2020, with bond rates hovering around 1% (1.5% below the expected inflation rate), buying long-term bonds seemed imprudent. With rates so close to zero, the potential for appreciation was minimal, while the risk of devaluation in a rising rate environment was significant.
For long-term bonds, a rate 1.5-2% above the expected inflation rate (currently estimated at 3.5%) is desirable. Alternatively, a real interest rate above the expected real growth rate is also favorable.
- Risk-Free Rate: Refers to US Treasury rates. The US government is unlikely to default since it can print money to repay its debts.
- Cash: Instruments with maturities ranging from overnight to two years.
- Bonds: Instruments with longer-term maturities, typically 19 years or more.
Conclusion: In the face of an inverted yield curve, short-term treasury bills present a prudent investment choice. By understanding the dynamics of interest rates, inflation, and economic growth, investors can make informed decisions that align with their financial goals.
How to buy Treasury Bills in your Wells Fargo Advisors Account
Ok now that we have covered the case to invest in short term Treasury Bills how do you do it?
In your Wells Fargo account go to “Screeners”
Then click on the “Explore Bonds” button
Then click on “Treasury” for the “Bond Type”
One of the things I don’t like on this next screen is the inability to filter by “Months to Maturity” instead there is only “Years to Maturity” and no way to put in a decimal to get less than 1 year. That said you can filter later so for this section I just put in a minimum yield threshold. Since current short term Treasury Rates are 5.5% I input 5 as the “Yield to Worst (%)”
In the results I recommend adding the maximum “Yield to Maturity” to be 1 since this will display a column showing each Treasury Bills ‘Maturity Date” like this. From here let us zoom into this Treasury Bill which has a Yield to Worst (%) of 5.354%
Now that we have clicked on the treasury the important information is the “CUSIP” number as this is the number you will need to share with your Wells Fargo Account Broker in order to execute the trade on your behalf.
In order to make the trade you need to call a Wells Fargo Investment Professional. You can find that number here.
So if we go through the math on this Treasury. The T-bills have a face value of $1000 which means when they mature you get $1000 back. You are buying them at a discount to face value today so when they mature the difference between what you paid and the face value is your interest return. In the Treasury bill above the price is 99.766 which means for a face value of $1000 you will pay $997.66 ($1000 x 99.766%). The difference is $2.34 which is the interest you would earn over the time in this case today is Oct 3rd, 2023 and the maturity date is 10/19/2023 so the time period is 16 days. Assuming you had $100,000 of cash laying around to invest you could purchase $100,000 / $997.66 = 100 Treasury Bills (they can only be bough in whole amounts). The total cost of this would be 100 x $997.66 = $99,766. So the amount of interest you would earn over the time frame would be = $100,000 - $99,766 = $234. The other way to get to that answer is simply 100 (# of Treasuries) x $2.34 (price spread per Treasury Bill) = $234.