Do you want to capture a higher yield amid rising interest rates? You may want to consider a Treasury Bill ladder. Treasury bills are low-risk investments, have predictable returns, and keep your money mostly liquid. In this guide, we break down what Treasury bill ladders are, how they work, how to structure them, and why savvy investors are secretly buying US Treasury Bills to generate over 4% annualized yield in a few months.
How does a Treasury Bill ladder work?
A Treasury Bill ladder is an investment strategy that involves spreading your money across several Treasury Bills with staggered maturity dates. The goal is to have a portion of the portfolio mature every few months or so, creating a steady stream of income. It gives you the chance to reinvest at higher rates as terms expire or to allocate the funds elsewhere. For example, let’s say you have $20,000 in extra cash. You can use $5,000 to buy a three-month Treasury bill, another $5,000 for six months, then buy 9 & 12 months with the remaining money.
In three months, when the first bill has matured, you can take a look at the current interest rate. If the rates are still high, then you can re-invest that $5,000 (plus the interest you earned) into another T-Bill. This allows you to take advantage of interest rates as they rise. If the rates have gone downare tumbling, then you can re-evaluate your options.
What are the advantages of a T-Bill ladder?
- Liquidity: Investors who build a T-Bill ladder can receive the benefit of earning the higher interest rates of longer-term investments while also being able to have some liquidity. By investing in this strategy, investors can access their cash regularly without having to sell their entire portfolio.
- Diversification: Building a diversified investment portfolio is essential. One way to achieve diversification is through a T-Bill ladder. A T-Bill ladder helps diversify an investor’s portfolio by spreading their investments across different maturity dates. It can help to mitigate interest rate risk, as the investor is not locked into a single maturity date.
We don’t really know if interest rates will stay the same, continue to rise, or go down in 2023. By building a Treasury Bill ladder, if interest rates go up in three months, by then, your three-month Treasury Bill will mature, then you can use that proceeds to buy a higher-yielding Treasury Bill. If interest rates go down in the next couple of months, then, you will have locked your money at a higher rate because you bought a nine and a 12-month Treasury Bill. - Predictable income: An investor can create a predictable income stream with a Treasury Bill ladder. This is achieved by reinvesting the principal and interest payments from maturing T-Bills into new T-Bills with longer maturities. Investors seeking stable returns can benefit from this type of investment.
What are the disadvantages of a T-Bill ladder?
- Limited maturities: T-Bills are typically issued with maturities of one year or less. This can be less attractive to investors who are looking for longer-term investment options.
- Interest rate risk: Treasury Bill ladders can mitigate interest rate risk, but they remain susceptible to changes in interest rates. If interest rates rise, the value of the longer-term Treasury Bills may temporarily go down.
How do you make a Treasury Bill ladder?
Building a T-Bill ladder is relatively simple. You need to purchase several T-Bills with staggered maturity dates.
You can buy and build a T-bill ladder through most brokerage firms or through treasurydirect.gov. You can also set up an automatic laddering system on the U.S. Treasury website so you won’t have to worry about micromanaging your investments. I personally like using Vanguard. I find their platform easy to use.
How to build a Treasury Bill ladder with Vanguard:
- Once you’re logged in, click on My Accounts, then click Buy & Sell under Transactions.
- Then click on Trade bonds & U.S. Treasuries, under CDs & bonds.
- Click on one of the rates across Treasuries.
- Choose the maturity of your liking.
- You can select a specific U.S. Treasury Bill.
- Input amount. In $1,000 increments.
- Review your Order. Click on ‘Submit Purchase’.
Do you pay tax on T-Bills?
Yes, Treasury Bills are taxed at the federal level using your marginal income tax rate. However, they are not subject to state tax or local income taxes. Make sure that you consult your tax advisor for more information.
What types of Treasury Bills exist?
There aren’t different types of Treasury Bills. Instead, there are T-Bills with various maturity dates. These can range from as little as 4 weeks to 12 months. 6-month and 12-month T-Bills are often referred to as “on-the-run” T-bills because they are the most liquid. 1 month, 3 months and 9 months are often referred to as “off-the-run” as they are less liquid and they are not as attractive to investors.
When is interest on a Treasury Bill paid out?
T-Bills don’t have interest payments. Instead, they are sold at a discount from their face value and upon maturity, the face value of the bill is paid out. For example, if you purchase a 6-month T-Bill Treasury Bill with a face value of $20,000 at a discount rate of 2%, you would pay $19,600 for the bill upfront. At maturity, you would receive the full face value of $20,000, and the $400 difference between the face value and the discounted price represents your interest payment.
The difference between what an investor pays for the bill and the face value is the return. This return is what some people call “interest”.
Will you purchase T-Bills in 2023?
Treasury Bills are a popular investment option for those seeking low-risk and predictable returns. While they are backed by the U.S. government, they are not entirely risk-free.
