Treasury bills, notes, and bonds have key differences that are important to understand when building a portfolio. In this comprehensive guide, we’ll break down the distinguishing features of these unique securities in terms of maturity length, interest payments, taxation, liquidity, and typical yields.
First, what exactly are Treasuries? Quite simply, they are debt obligations issued by the federal government to finance operations and pay obligations. The backing of the US government makes Treasuries appealing to investors looking for relatively low-risk investments.
Treasuries come in three main “flavors”:
In addition to differing maturity lengths, these types of Treasuries vary in other factors like how interest accrues, timing of payments, taxation nuances, liquidity profiles and yields. Grasping these key differences is crucial to effectively using Treasuries in a diversified portfolio.
T-bills are short-term government securities with maturities less than a year. Specifically, they are issued at regular auctions with terms of 4, 8, 13, 17, 26 or 52 weeks. Their short length makes them very liquid as investors can easily wait out the few months until maturity.
A unique feature of T-bills is that they do not make periodic interest payments like bonds. Rather, they are sold at a discount to their face value. For example, you might pay $980 for a $1,000 bill. When the bill matures, you would receive the full $1,000 face value. The $20 difference between the purchase and maturity amount represents the interest earned.
This characteristic gives T-bills very predictable returns equal to the difference between the purchase price and face value at maturity. It also means yields on short-term T-bills are typically lower than longer-term government bonds. The lack of regular interest payments can make T-bills attractive for short-term cash management purposes.
Treasury notes fall in the medium-term area with maturities between 2-10 years. Many investors favor notes because they strike a balance between capturing higher yields than bills without committing to super-long maturities like bonds. Treasuries maintain liquidity quite well compared to corporate bonds of similar maturity which also appeals to some investors.
Unlike T-bills, Treasury notes pay interest every six months based on the fixed coupon rate determined when the note is auctioned. For example, a 5-year note with a coupon rate of 2% would make biannual interest payments of $10 for every $1,000 of face value.
The coupon rate serves as a benchmark, but notes can trade above or below face value after issuance. If market interest rates increase after a particular note is issued, its resale price will decrease to match prevailing rates. The inverse occurs when rates decline.
Treasury bonds represent the long end of borrowing for the federal government. They come with maturities of 20 or 30 years. This locks investors in for the long haul, but also gives issuers more flexibility to borrow substantial sums with less frequent refinancing compared to shorter maturities.
Like notes, bonds pay interest every 6 months at the stated coupon rate determined at auction. And their market value similarly fluctuates above and below the face value based on interest rate changes after issuance. If market rates decline relative to a bond’s fixed coupon payments, then the bond’s price will rise proportionally above par to match the yield investors can get on newer bonds.
The lengthy terms of Treasury bonds allows them to capture higher base interest rates driven by the added uncertainty of committing money further out. But it also introduces greater interest rate risk should the market see fit to subsequently increase rates after issuance.
The unique characteristics of Treasury bills, notes and bonds allow investors to harness them to achieve certain portfolio-enhancing benefits:
As with most investments, utilizing Treasuries comes with tradeoffs between risk, reward and committing your money for various time periods.
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