Why You Should NOT Invest in Treasury Bills, Notes, or Bonds

It may seem counter-intuitive: in these uncertain times, when stocks drop 50% in one day and bank interest rates do not even try to keep up with inflation, what better place to stick your money than in treasury bills? However, just because everyone else is placing their money into treasury bills doesn't mean you should be too. After all, as your mother used to say, "if everyone jumped off a bridge, would you jump off too?" In other words, don't be a lemming.

First, let's refresh our memories with a quick lesson about what are treasury bills (T-bills), treasury notes (T-notes), treasury bonds (T-bonds), and treasury inflation-protected securities (TIPS). T-bills are securities sold by the government with a maturity of 3 months to 1 year, and they are sold at a discount compared with their face value. T-notes have maturities of 2, 3, 5, 7, and 10 years and accumulate interest every 6 months. T-bonds are issued for 30 years and pay interest every 6 months. TIPS are currently issued for 5, 10, and 20 years and have their principal adjusted according to changes in the Consumer Price Index (a measure of inflation).

The U.S. government issues treasury securities as a way of borrowing money in order to fund wars, major projects, etc. For example, the U.S. issued "war bonds" during World War I in order to finance its involvement in that war. At first, U.S. citizens were the major creditor for U.S. debt. However, as that debt increased, American funding was exhausted. Foreigners and foreign countries started taking on the excess debt, and today own about 29% of all U.S. national debt (1).

Currently, the United States owes $11.5 trillion to all its creditors. Who are these creditors? The major ones are as follows: China ($801.5 billion), Japan ($677.2 billion), Caribbean ($194.8 billion), Oil Exporters ($192.9 billion), United Kingdom ($163.8 billion), and Brazil ($127.1 billion) (1). The U.S. is increasingly relying on foreign money to support its debt, and that debt is increasing. From 2001 until 2009, the Bush administration increased U.S. debt from $5.7 trillion to $10.6 trillion. Since the advent of the Obama presidency, the U.S. debt has increased by almost another trillion dollars.

How does the national debt relate to T-bills? There are two ways: current rates, and supply and demand economics. Currently, the U.S. pays very little on its debt: a 3-month T-bill earns about 0.16% in interest. A 10-year T-note pays an interest rate of only 3.65%. Even the 30-year bond is going for a measly 4.54% (2). These rates do not keep up with inflation, much less make the creditor (including you) any profit. The one exception to this might be in TIPS, which will at least keep up with inflation. So, it stands to reason that, as the U.S. continues to increase its debt, creditors will start balking on extending any more credit. This will force the U.S. to raise its interest rates.

When interest rates on U.S. debt change, they may change drastically. This is because, as of late, the value of the U.S. dollar has been declining. In light of the dollar's decreasing monetary value, foreign capital will command a higher interest rate.

Investors who have already purchased T-bills and the like will be in for quite a shock once interest rates start rising. There won't be too many options either, because selling the securities at maturity and after the interest adjustment will pay out only the interest rate at which the securities were purchased. Another alternative might be to cash out all treasury securities now and wait until the interest rate change; however, with current interest rates so low, any cash out is bound to result in a loss of capital.

So, what can you do, and invest in, in the meantime? If you are still hoping to earn a fixed income from your assets, consider buying bank certificates of deposit (CDs) that pay the highest interest. Compared with government securities of similar maturities, CDs still provide a higher return overall.

Alternatively, invest in the stocks of companies that have been around for decades and have faithfully offered dividends to shareholders. Look for companies that have raised their dividends over the years. That way, even if you start out with only a 3% dividend, over time your average return will increase. And don't forget that stock prices also rise, and stocks often split, further increasing the return on your initial investment.

References:

1. United States Treasury Major Foreign Holders of Treasury Securities July 16, 2009.
2. U.S. Treasury TreasuryDirect Average Interest Rates on U.S. Treasury Securities