Building your wealth
Are 2-Year Treasury Notes a Good Investment Right Now?
When it comes to the short term, the options for investors have been limited—not in the types of investments, but regarding the potential returns. Since 2009, the Federal Reserve has kept interest rates below 2.5%, making it difficult for investors to earn a decent return in the short term.
All of that changed with the events surrounding the pandemic. Government spending, supply chain issues, lockdowns, and more contributed to inflation.
To fight inflation, the Federal Reserve is raising interest rates. This means investors can earn a higher return on short-term investments, specifically Treasury bills. But are they suitable investments for you?
U.S. Treasuries are debt instruments backed by the U.S. government. Since most experts agree the U.S. government will not default on its debts, Treasuries are considered risk-free investments. In other words, there is an implied guarantee that you’ll get your principal investment back, along with interest.
The complication with Treasuries is how they are named. Treasury bills are bonds that mature in one year or less. Unlike traditional bonds that you purchase at face value and then earn a stated interest rate, Treasury bills sell at a discount to face value. When they mature, you receive the face value, and the “interest” you earn is the difference between your purchase price and the face value.
Treasury notes are bonds that mature in more than one year but less than 10 years. Treasury bonds mature in 10 to 30 years. In both cases, you purchase the bond for face value, and every six months, you earn the stated interest rate until the bond matures.
As of this writing, here are the current interest rates (APY) for various term Treasuries:
This is a risk-free rate of return that is hard to find in other investments. You could invest in I Bonds, which are yielding over 9% at the time of this writing. However, you cannot sell these for at least one year, and if you sell within the first five years, you forfeit three months’ worth of interest.
Compare the rate of the 52-week Treasury to high-yield savings accounts, and you are earning double that amount or more with the Treasury. Of course, you have to take into account inflation as well. With the August consumer price index (CPI) report, the inflation rate is 8.3%—double the Treasuries' interest rate. In other words, you are still losing out to inflation by going this route.
The alternative option, the stock market, doesn't offer a risk-free or guaranteed return either. Many economists believe that inflation will not be going any higher, so Treasuries could be a smart way to limit the loss of purchasing power.
Finally, consider what would happen if inflation fell over the next 12-24 months. If you think inflation will be below 4% within two years, then investing in five-year Treasuries and earning 4.15% is a great deal.
TIPS, or Treasury Inflation-Protected Securities, act like traditional bonds but with a feature that allows the face value to change based on inflation. For example, if you purchase a 30-year TIPS bond with a 4% interest rate, you will earn 4% for the life of the bond. The face value, however, will go up or down based on inflation.
Earning interest, in addition to having the value of the bond increase in value, sounds like an ideal investment. The problem is there is risk involved with TIPS. If inflation drops, the bond will fall in value. So while you still earn the stated interest rate, it could be offset with the loss of principal.
Treasuries, on the other hand, will not lose value unless you sell them on the secondary market before they reach maturity. But if you invest strategically, using a bond ladder with various maturity dates, you should avoid running into this problem.
If you were to invest in a TIPS mutual fund or exchange-traded fund, you also open yourself up to principal loss here. Even if you don't sell, but other shareholders do, the fund's overall value will decline. This is evident in the iShares TIPS Bond ETF (TIPS), which is down 11% for the year as of this writing.
If you want to invest in TIPS, purchase individual securities and the shortest term possible (five years) to limit your potential losses.
Corporate bonds have various maturity dates like Treasuries and pay a competitive interest rate, depending on the bonds rating. But the same issues we saw above with TIPS also play out with corporate bonds.
If you invest in longer-term corporate bonds, you can lose money if you have to sell before the bond matures. If you invest in a mutual fund or ETF, you will lose money as other shareholders sell. To protect yourself, purchase individual corporate bonds for the shortest term possible or bond funds that have a short duration.
At the end of the day, you have to look at your financial situation, goals, and risk tolerance to determine your best investment. There is no perfect investment to try to keep pace with rising inflation.
All you can do is make smart choices to protect your money and help it grow safely. For some investors, this might mean investing in Treasuries. For others, buying individual corporate bonds might make the most sense.
There are two options for buying Treasury securities. You can visit TreasuryDirect.gov, where you can purchase them directly from the U.S. government. There are no fees or commissions. However, you can only access your bonds through this website.
The other option is to buy from a bank or broker. This is known as the secondary market, and it has its advantages and drawbacks. The benefit of this option is you can purchase Treasuries with different maturities. Since you can't buy a four-month Treasury directly, you can purchase this term on the secondary market. The catch is it won't be an exact four-month bond. Instead, it could be a 6-month bond that matures in four months.
The downside to the secondary market is you are likely to pay a fee or commission, and the interest rate you earn will be slightly less. However, most investors that go this route agree that the flexibility of bond terms and having all their investments with a single broker is worth it.
Now that the Federal Reserve is raising interest rates, short-term investors have more options for earning a competitive interest rate. The only thing left is figuring out which investment option makes the most sense for your goals, risk tolerance, and time horizon. Once you understand this, you will have a good idea of where to invest your money.
This article was written by Q.ai - Powering a Personal Wealth Movement from Forbes and was legally licensed through the Industry Dive Content Marketplace. Please direct all licensing questions to firstname.lastname@example.org.
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