A Treasury Bill or T-Bill is a debt obligation issued by the U.S. Department of the Treasury. Of the debt issued by the U.S. government, the T-Bill has the shortest maturity, ranging from a few days to one year. T-Bills are typically sold at a discount to par value (also known as face value). When the bill matures, you are paid par value. The difference between your purchase price and par value represents your interest.

Basic Characteristics
The primary difference between a T-Bill, a Treasury Bond and a Treasury Note is the maturity date. The Treasury Bond has the longest maturity at 20 or 30 years, though maturities of 50 and 100 years are also under consideration.  The Treasury Note matures in two to 10 years. The T-Bill matures in a year or less. The debt is issued by the U.S. Treasury to raise capital, and the return of the principal plus interest is guaranteed to investors regardless of what happens in the stock or bond markets.

T-Bills can be purchased in increments of $100 (in maturity value). They resemble zero-coupon bonds in that they are issued at a discount and mature at par value, with the difference between the purchase price and par value representing the interest paid to the investor. For example, a T-Bill with a maturity of 26 weeks might be sold for $999.86 and mature at a value of $1,000. The discount rate is calculated at the time of auction.

T-Bills are issued in maturities of 4, 8, 13, 26 and 52 weeks. All maturities are auctioned every week, except for the 52-week T-Bill, which is sold every four weeks.

Investors can submit two different types of bids for T-Bills:

  • Non-competitive bids: This type of bid is akin to a market order. The investor agrees to accept the discount rate determined at auction. Investors who take this bid are guaranteed to have their orders filled. A noncompetitive bid can be placed through Treasury Direct or a bank or broker.
  • Competitive bids: With this type of bid, the investor specifies the discount rate they are willing to accept. If your bid is better than the discount rate set in auction, your order will be filled. Otherwise, your order could be partially filled or rejected. This type of bid cannot be placed through Treasury Direct. You must use a bank or broker.

In a single auction, investors can buy up to $5 million in T-Bills in non-competitive bidding, or 35% of the offering amount in competitive bidding.

Yield and Tax Treatment
The interest that is paid on T-bills is taxed at the federal level and exempt at the state and local level. For this reason, T-bills are attractive to investors in states with high tax rates. Investors have the option of having up to half of the interest paid on their bills withheld for tax purposes.

The yields on T-Bills are typically slightly lower than comparable securities such as CDs. This is because of their perceived safety due to the governmental guarantee of interest and principal. Of course, the yield on a T-Bill rises as the time to maturity lengthens.

Investment Strategies
Investors with short time horizons can use a laddering strategy to maximize yields and minimize risk. This concept allows parcels of cash to become available periodically that can be reinvested at prevailing market rates. Another strategy is to invest the majority of a portfolio into T-Bills and then allocate a very small percentage into aggressive assets such as derivatives that could appreciate substantially if the markets move in the right direction. Of course, if the markets move in the opposite direction, the T-Bills will grow back to the original amount of principal at maturity. Or they may need to be reinvested a time or two, depending on the ratio of T-Bills to risky assets in the portfolio.

Of course, because the primary characteristic of T-Bills is they offer a guaranteed return of principal, they typically function as the "safe" portion of an investment portfolio. They are often used in lieu of cash by knowledgeable investors who understand they pay a higher rate of interest than cash instruments or accounts such as money market funds. This also makes them attractive for institutions bound by fiduciary requirements that prevent them from risking the principal of their funds in any way. However, T-Bills are still subject to both inflation risk and interest-rate risk, and investors who seek to outperform the markets over time should generally look elsewhere to fulfill their investment objectives.

The Bottom Line
T-Bills are useful for conservative investors who seek higher yields than what are available in cash accounts such as money market funds. Although T-Bills rarely offer real inflation-adjusted returns, they do offer liquidity, safety of principal and exemption from state and local taxation.