One of the big headlines last week was in regards to the yield on 4-week treasury bills hitting 0%. That means if you invested in one of these, it would earn the same amount of interest as if it was hiding under your mattress. It seems absurd — why would anyone invest in something earning no interest when there are plenty of safe and insured accounts available still paying at least 3%?
For the average person, it’s easier to keep your safety net in things like a savings account or CD at the bank. Besides, they are FDIC insured if you’re within the coverage limits, so why even bother with treasury bills? But there is still a strong demand for treasury securities, and last week when they were auctioned off at 0%, most investors were not even able to fill their entire order. So, who’s buying these zero-interest bonds and why?
The Real Investors
While regular folks like you and me can invest in treasury securities, we aren’t driving the market. Treasuries are where institutions play. When it comes to big money market funds, and cash/income components of various mutual funds or other investments, these institutions are usually buying up treasuries. Especially with money market funds, since safety is paramount, these securities are the go-to place to find safety. That being said, this is where billions of dollars are traded. Yield, or rate of return isn’t as much of a concern as protection of principal, so the 0% rate is of little concern.
In addition to institutional investors, foreign banks are the other major player. In fact, the government reports that about half of the over $5 trillion in publicly traded debt is owned by foreign nations — namely China. Even with the economic turmoil here and abroad, U.S. debt is still viewed as one of the safest investments around the globe. So, when yields are down, it doesn’t matter when you’re looking for absolute safety on a global scale.
And finally, you have many pension funds investing heavily in safe investments like treasury securities. Just like money market mutual funds that seek safety, you have plenty of pension funds worth billions that need to be able to keep up with paying current retirees, and to allocate investments in this economic climate to protect what assets they do have.
Alternatives to Treasuries
Even though most investors dealing with treasuries are very large companies or even foreign banks, there are still a number of people who invest in these products on their own. But why would you settle for 0% when there are many other safe alternatives paying more?
Right now, you can find an FDIC insured savings account paying anywhere from about 2-3% without many restrictions. In fact, FNBO Direct is paying 3.25% right now. Now, if you’re someone that has millions of dollars that go above and beyond the FDIC limit of $250,000, savings accounts might not be a viable option if you want complete safety. But for most people who fall within the FDIC limits, investing in an insured savings account is basically as safe as investing in the U.S. government directly.
Certificates of Deposit
You can still find attractive CD rates right at your local bank — in some cases, over 3.5%. Again, if you’re with an FDIC insured institution and fall within the limits, this money is perfectly safe. But when it comes to CDs, there may be a few drawbacks. One benefit of treasury securities is that there is a market for them, and if you need the money, you’re free to buy and sell as you see fit. With a savings account, you’re also liquid. But CDs are intended to be held for a predetermined amount of time. If you want to take the money out early, you may face a penalty or have to give up some of the accrued interest in order to do so.
Inflation Protected Bonds (I-Bonds)
Even though you are ultimately protected by FDIC, which is backed by the government, with things like savings accounts and CDs, some people would still feel more comfortable lending directly to the government. That’s fine, and there is actually a type of bond that is still doing quite well, and it is the I-Bond. The I-Bond is designed to keep up with inflation. The interest rate it pays is made up of two components: the base rate, and the semi-annual inflation rate. So, the rate you get on these bonds is good for six months. Right now, the composite rate comes out to 5.64%, which is far better than 0%.
But, there is one big snag. Currently the limit of I-Bonds you can purchase in a calendar year is just $5,000 $10,000 ($5,000 in paper bonds, and $5,000 through Treasury Direct online). If you need to save more than that, you’re out of luck. In addition, you need to hold these bonds for one full year before redemption. After that, if you redeem a bond before five years, you will have to forfeit the most recent three months of interest. After five years, there is no penalty. So, these are long-term savings options for smaller amounts, but if that fits your goals for the money, they are an attractive option. The I-Bond is just one of a few types of savings bonds, but it is the only one with a rate worth seriously considering over the other savings options.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
These are very good tips! I actually just opened a savings account myself, as these are great rates for small investors such as myself.
"One of the big headlines last week was in regards to the yield on 4-week treasury bills hitting 0%. That means if you invested in one of these, it would earn the same amount of interest as if it was hiding under your mattress."
Your mattress has to be fireproof... and burglar proof. :)
Good point Mr. GoTo, I forgot that the $5k limit was for each method of purchase and not as a whole. I'll update that.
And yes, tax deferral is certainly another worthy consideration. Thanks for catching that.
Jeremy: Excellent analysis. A point of clarification on I-Bonds. You can actually purchase $10k per year, $5k online and $5k in paper bonds. Another very important advantage of I-Bonds over other Treasuries is that the interest is tax deferred. You don't pay any tax on accrued interest until you redeem the bond.