Mar 27, 2023
Treasury Bills - Too Good to be True?
Managing liquidity in relation to your financial goals is important, but don’t underestimate the need to do so in a prudent manner. We think investing a portion of your capital in short-term Treasury Bills (T-Bills) makes sense if you can match up their maturities with expenses that are due in a similar timeframe. But what about holding T-Bills as a longer-term investment strategy, given today’s market volatility and shifting macroeconomic conditions?
Cash outperformed most investments in 20221 and has finally become a yielding asset class again, but receiving 5% on short-term Treasury bills may not be as attractive as it sounds. Investors may think a risk-free 5% return is currently the best option, but are T-Bills truly risk-free? Let’s explore some of the risks we believe investors should be taking into consideration.
Inflation
Inflation remains high, with prices measured by the Consumer Price Index increasing by 6% relative to the same time last year.2 T-Bills are yielding below this level,3 and we believe this implies that inflation will still erode purchasing power. This dynamic also applies when we look at history. T-Bills have only provided a 0.4% real return (inflation-adjusted) per year since 1926.4 In stark contrast, bonds and large-capitalization stocks have provided inflation-adjusted real returns of 2.6% and 7.4%,5 respectively, over the same period. Investing for the long term typically requires real growth in your portfolio, and history has shown that T-Bills usually do not meet the bar.
Reinvestment risk
If they’re not using T-Bills for short-term liquidity needs, people typically reinvest the proceeds when the security matures. Yes, we’re presently seeing attractive rates, but do we know how long they will last? We don’t. This is what we consider a key risk; settling for T-Bills now may result in missing out on the opportunity to lock in higher rates for longer periods.
As shown in the following example, we can purchase investment-grade corporate bonds with maturities of five to 10 years, yielding over 5%. Not only does this show that we may capture higher yields for longer, but we could see the bond’s price increase if interest rates decrease in the future (bond prices traditionally move in the opposite direction of interest rates).
| Total cumulative return if no change in interest rates* | Total cumulative return if rates increase by 1% each year* | Total cumulative return if rates decrease by 1% each year* | |
|---|---|---|---|
| Treasury Bill (5% starting yield with one-year maturity) | 15% | 18% | 12% |
| Intermediate-term, investment-grade corporate bond (5.5% starting yield) | 16.5% | 4.5% | 28.5% |
*Hypothetical returns do not represent actual or expected investment performance.
Assumptions: Both investments are held for three years (T-Bills reinvested annually). Interest income is not reinvested, and compounding is not considered. T-Bill price fluctuations due to interest rate movement are assumed to be negligible. Duration of investment-grade (IG) corporate bond assumed to be six years, default risk assumed to be negligible given a <0.3% IG historical default rate and credit spreads assumed to remain constant.
We believe double-digit returns from T-Bills look good, but markets are currently forecasting that the Federal Reserve is nearing the end of its cycle of raising rates. In fact, interest rates are expected to drop to approximately 4% by the end of 2023 and decline even further through 2024.6 You may disagree with market consensus, but in our opinion, it proves to be correct most of the time. Inflation has been cooling off recently as economic growth slows7, and we believe it would be wise to capture higher yields now for longer periods. If consensus is correct, certain corporate bonds may more than double the return of the T-Bill, as seen in the third column of the above chart. Even if market consensus is incorrect and rates continue to rise, we should still be left with a positive return after three years, in addition to several years of continued income generation until the bond matures at par. It’s worth noting that intermediate-term, investment-grade corporate bonds may be subject to increased interest rates and credit risks versus T-Bills.
We believe financial success is a marathon, not a sprint. The allure of guaranteed returns in an uncertain environment is tempting, but growing your capital for the long haul usually requires growth in excess of inflation. When it comes to money that you’ll be depending on for years to come, there’s a significant opportunity cost of placing assets in short-term investments, given that attractive yields on long-term bonds likely won’t stick around forever. Try looking at the bigger picture to determine the balance of assets you need for liquidity purposes versus those assets where a long-term strategy would be more appropriate. We feel there are numerous options in multiple asset classes that may offer higher returns than Treasury Bills over the long run.
1 https://www.blackrock.com/us/individual/literature/investor-education/asset-class-returns-one-pager-va-us.pdf
2 www.bls.gov/cpi (as of 2/28/23)
3 https://fixedincome.fidelity.com/ftgw/fi/FIYieldTable?popupMode=Y&yldTabSelected=H
4 Long-Term Performance of Stocks, Bonds, T-Bill and Inflation 1926-2021, Martin Capital Advisors
5 Long-Term Performance of Stocks, Bonds, T-Bill and Inflation 1926-2021, Martin Capital Advisors
6 According to the CME FedWatch Tool
7 https://www.federalreserve.gov/monetarypolicy/files/20230303_mprfullreport.pdf
ABOUT THE AUTHOR
Sagar Shah
With more than a decade of financial services experience, Sagar Shah joined RegentAtlantic as Client Portfolio Manager. In this capacity, he is responsible for developing and communicating content for the Firm's investment philosophy and interacts regularly with RegentAtlantic's clients about their investment portfolios.
As a core member of the Investment Team, he plays an instrumental role in investment-related communications and analysis. Sagar previously held roles in equity research, healthcare finance, and treasury at large institutions.
Sagar graduated with a BS in Biology from The College of New Jersey and holds an MBA in Finance from Rutgers University. He is also a CFA Charterholder and a member of the CFA Society of New York. He has been cited in numerous investment-related publications including Forbes Intelligent Investing.
In his free time, Sagar enjoys working out, outdoor activities, reading, and spending time with family and friends.
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