The case for 12-month Treasury Bills
We just ended the worst week in the stock market in a decade. That's the worst 1-week stretch in 510 weeks!
While there is a strong case to be made for a market recovery, this post is not about stocks - it's about Treasury Bills, now yielding the most they have since 2008 at just over 2.5%. Rates have gone higher with the Federal Reserve raising short-term interest rates. The Fed has raised rates 9 times in the past 3 years, when rates were at 0 to help the economic recovery from the recession. With short-term rates this high, we can no longer ignore Treasury securities as a viable alternative to cash in portfolios.
What is a Treasury Bill?
A Treasury Bill or "T-Bill" is a short-term debt instrument, much like a bond that is backed by the Treasury Department of the U.S. government. Treasury securities are known as risk-free assets because they are backed by the U.S. government and not by a corporation or municipality. Risk-free means investors will be paid back, guaranteed.
T-Bills have a maturity of 12 months or less and are sold in increments of $1,000 up to a maximum purchase of $5 million.
When an investor buys a T-Bill, the U.S. government effectively gives you a promissory note saying they will pay you back at "par." T-bills don't pay interest payments like a bond, but are sold at a discount to par.
For example, if you buy $100,000 worth of T-Bills, you will pay something close to $97,500 today or something close depending on the price at the moment you purchase them.
If you buy 100 T-Bills for $97,500, they will mature in 12-months at $100,000 and you will have made 2.5% or $2,500. Not a great return compared to the long-term average of stocks, but a phenomenal return compared to the near 0 return on cash.
The most important question of 2019
The first question we'll be asking clients in the new year is what percentage of their portfolio do they want in cash. But, instead of cash, we'll be looking at T-Bills as an alternative, because they actually provide a return at the end of the year.
25% of a portfolio in cash or T-Bills is a good place to start. With an economic slowdown and sky high volatility, more isn't a bad choice, something like 30% or 40%. Extremely conservative portfolios could have 50% - 75% in T-Bills but the tradeoff will be missing out on the eventual recovery in the stock market
T-Bill prices will fluctuate based on economic conditions, but short-term rates typically fluctuate less than long-term rates. Imagine a teeter-totter. The further you get out to the ends of the teeter-totter (long-term treasuries, like 30-year maturities) the more up and down you get. The closer to the middle, the less fluctuation. This is another reason we like 12-month T-Bills because the price fluctuates less.
The most important question investors can ask in 2019 will be, how much protection do I want in my portfolio? Instead of cash, consider the alternative of T-Bills and you may sleep better at night knowing your money is working for you instead of just sitting there doing nothing.
In a managed account that charges 1% of assets, take this fee into consideration when allocating to Treasury Bills and cash. A 12-month T-Bill yielding 2.5% will yield 1.5% net of a 1% fee at the end of the year.