Friday, November 24, 2006

Investing with T-bills

A reader posed the following questions concerning investment in U.S. Treasury T-bills via TreasuryDirect:

  1. How does the C of I account work?
  2. How can I automatically reinvest rather than having the money make the trip in and out of the bank?
  3. What is signaled by the fact that in recent Treasury auctions the 4-week T-bill yield has been higher than the 13-week and 26-week T-bill yields?

Here is my response:

TreasuryDirect needs a place to "park" your cash both before a Treasury bill (or note or bond) is purchased, and after it matures. You have two choices: 1) park the cash in your own bank account, where you might earn some interest, or 2) park your cash in the C of I account, which earns zero interest.

The C of I is a "free" convenience that lets you invest in Treasuries without the government knowing who you do banking with.

There may be some other esoteric benefits to the Zero-Percent Certificate of Indebtedness, but I haven't heard of them, yet.

Note that if you use the C of I for "funding" purchases and have an automatic re-repurchase order for T-bills, the "interest" on your T-bill will accumulate in the C of I without any compounding. That is a great way to "donate" money to the government!

My plan is to transfer the T-bill interest from my low-interest bank account to my higher-interest Fidelity brokerage account so that I get some degree of compounding.

If your 4-week T-bill investment is large enough, around $250K, the monthly interest would be enough to purchase another $1,000 of T-bills, so you could get compounding by simply upping your purchase amount each month. If you had $120,000 in 4-week T-bills, you could up the purchase by $1,000 every other month, but you wouldn't earn any interest on the T-bill interest for the odd months. These numbers assumed a 5% investment rate.

TreasuryDirect allows you to "schedule" purchases a long way into the future. To automatically re-order T-bills as they mature, you simply schedule the same order for as long a period as you desire. You can't simply say "until further notice", but you can specify a fairly large number.

Unfortunately, TreasuryDirect does not maintain a single order as being a repetition, but actually queues up a long list of distinct orders that can be managed separately, so if you enter a large repetition count you will have to do a lot of deletes to get rid of the orders if you want to change your schedule or amounts. Scheduling for a year may make sense since you should review your investment plan annually anyway.

After selecting "Buy Direct" and then "Bills", the "Buy Direct >> Treasury Bills" web page has a section entitled "Purchase Frequency". Select "Schedule repeat purchases", enter "Number of Repeat Purchases" and the "How Often" time interval. Select "Monthly" for the four-week T-bill even though that interval is technically not exactly correct. You might also buy the T-bills on a weekly or bi-weekly basis, but be sure to divide your total investment by two or four if you do so. Or divide by 13 if you wish to buy three-month T-bills every week, or divide by 3.25 (13 divided by 4) if you wish to buy 3-month (13-week) T-bills every four weeks.

I only have experience with the 4-week T-bills since July and you never hear even the financial media discuss them. Generally speaking, a higher yield means there is lower demand, suggesting that people feel that they have somewhere else to put their money to earn a higher return. My recent suspicion is that short-term speculators in commodities are continuously deciding even on a weekly basis whether to be "in" or "out" of various speculative opportunities, and being "in" means they would be less interested in T-bills. Precious metals commodities were rising in recent weeks.

Some people believe that the Fed may cut interest rates in a few months, so buying a six-month T-bill will lock in a rate for six months. That means higher demand for the six-month T-bill, which means a lower yield.

And there is always demand for the "benchmark" three-month T-bill. Of course, that demand varies from week to week, so we see the weekly investment rate vary as well.

There has been a lot of volatility in T-bill yields in the past few months, so it is difficult to say that there might be a trend, especially since the Fed has been "paused" for that period and is likely to be paused for at least the next couple of months as well.

I automatically re-ordered the 27-day T-bill this week and got lucky with a 5.25% investment rate, but I have no feeling for what the yield will be next week or in four weeks when my next automatic re-order occurs.

I keep meaning to find out what services Fidelity offers for investing in Treasuries, other than government bond funds which charge a management fee, but I haven't gotten around to it yet. TreasuryDirect seems like it has to be the lowest cost vehicle for investing in T-bills. The only advantage a fund manager could give would be to intelligently decide between the various durations of T-bills or other government securities besides Treasuries, but I have no knowledge about whether such a manager even exists at the retail level. The big investment banks make (and lose) huge amounts of money trading Treasuries and are unlikely to want to "give" any of that money to you or I by clueing us in on their trading secrets. A lot of their trading is in notes and bonds anyway.

The current Treasury yield curve with T-bill yields well above T-notes and T-bonds is quite an anomaly and usually doesn't persist for long (e.g., it starts when speculators smells a recession coming and ends as the Fed lowers short rates), but this time it may persist if the Fed is "right" and keeps the economy out of recession without lowering the Fed funds target interest rate from its current "neutral" stance and also keeps inflationary expectations relatively low.

A lot of people are betting heavily against the Fed (buying notes and bonds), but just because they are betting that outcome doesn't mean they are likely to be proven correct.

There are plenty of other factors putting downwards pressure on the long end of the Treasury yield curve. For example, a lot of 401K investors are still leery of the stock market and continuing to pour vast sums of money into bond funds, which puts downwards pressure on bond yields, especially as more "boomers" get incrementally closer to retirement and shift more of their assets to fixed income.

Even if an investor has a simple, "normal" asset allocation, a sizable chunk of any new investment will still be pouring into bond funds and pushing downwards on yields.

For now, we should simply savor the benefit of a higher return with less commitment and more flexibility that we get with T-bills. Better than a free lunch, it's like getting paid to eat lunch.

-- Jack Krupansky


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