In times of changing interest rates, Wall Street traders like to say, “Don’t fight the Fed.” With returns on bond funds plummeting that could be good advice for fixed-income investors, too. Let’s take a look at why bonds are plummeting and whether investors should put their money in alternate investments.
A financial advisor can help rebalance your portfolio when interest rates change.
Why Bonds Are Plummeting
Since March, the U.S. Federal Reserve Bank’s Open Market Committee has hiked domestic interest rates five times, from nearly 0% to 3%, lowering the value of existing bonds. And the global bond market took an additional hit during the last week of September, when the very proper Bank of England announced a bond-buying spree that will lower interest rates there, causing rates on existing U.K. bonds to swing wildly.
The reason for these rate hikes is the war central bankers are waging on inflation, which has soared globally and stands at 8.3% as of September in the U.S., and this is far from the Fed’s long-run 2% inflation target. That means more Fed hikes are likely, and the central bank’s own forecast predicts that rates could go as high as 4.6% in 2023. That could mean more losses for stocks and bonds. How much, no one knows.
What we do know is that that Fed hikes directly result in higher rates on U.S. Treasuries, which many investors consider a safe investment. Buying into the rising rates of Treasuries means investors can get positive returns at very low risk.
One way to profit on that trend is by building a Treasury bill ladder.
How You Can Make Money With a Treasury Bill Ladder
A Treasury bill ladder consists of a series of short-term Treasury bills that can be rolled over to higher rates every time they mature. Because investors hold the bills until maturity, they don’t have to worry about changing values in the secondary market. As interest rates rise, every increase is captured in the next T-bill purchase, which raises the investor’s yield. If the investor needs cash at that moment – or finds a better investment – they can simply take the money and move on. The same tactic applies when Treasury rates start to decline, thanks to the short duration of the bills.
You can buy T-bills through most investment platforms, usually at a minimum investment of $1,000, or straight from the government at TreasuryDirect.gov, where the minimum investment is a mere $100. And while bank interest and gains on other bonds are subject to state, local and federal tax, profits from Treasuries are taxed only at the federal level, as ordinary income.
Here’s an example of a very simple three-bill ladder strategy from investment advisor Jennifer Lammer:
- The investor purchases a four-week bill, an eight-week bill and a 13-week bill, all in equal amounts.
- When the four-week bill matures, the investor buys a new 13-week bill, at what’s expected to be a higher rate.
- When the eight-week bill matures, the investor buys another new 13-week bill, at what’s also expected to be a higher rate.
- The investor now has a ladder of 13-week Treasuries, with one maturing every four weeks that can be rolled over into another 13-week T-bill.
- This strategy can be repeated until rates start to decline, the investor needs cash, or the investor finds a better alternative investment.
Here’s what the returns would look based on the most recent T-bill auction:
- 4-Week Treasury:2.703%
- 8-Week Treasury:3.122%
- 13-Week Treasury:3.343%
Now, compare that to the highest bank CD and money market account rates:
- 1-Month CD: 0.50%
- 2-Month CD: 0.50%
- 3-Month CD: 1.15%
- Money Market: 2.85%
Investors who want to use a longer holding period could construct a similar ladder using a strategy outlined by David Enna, which uses six 26-week bills purchased monthly for six months, which can be rolled over monthly after the first one matures.
Bottom Line
Because they’re such low-risk investments, a ladder of Treasuries won’t give you huge returns but it will give you positive returns that will beat bank certificate of deposits and money market accounts, while producing gains that can offset inflation.
Investment Tips for Investors During Interest Changes
- If you’re unsure which asset allocation mix will help you meet your investment goals when interest rates change, afinancial advisorcan help you compare different options for your financial plan.SmartAsset’s free toolmatches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals,get started now.
- SmartAsset’s freeinvestment calculatorcan help you estimatehow much your money could grow over time.
Photo credit: ©iStock/Andrii Dodonov,©iStock/grandriver,©iStock/gerenme
FAQs
Bottom Line. Because they're such low-risk investments, a ladder of Treasuries won't give you huge returns but it will give you positive returns that will beat bank certificate of deposits and money market accounts, while producing gains that can offset inflation.
Is laddering Treasury bills a good idea? ›
A T-Bill ladder helps diversify an investor's portfolio by spreading their investments across different maturity dates. It can help to mitigate interest rate risk, as the investor is not locked into a single maturity date.
What are the disadvantages of bond laddering? ›
Understand the risks before building your bond ladder: Interest rate fluctuations. Interest rates don't always increase, which can mean returns from your fixed-income ladder could be lower than expected.
What is the ladder strategy for the Treasuries? ›
A T-Bill ladder is a strategy that involves sequentially purchasing investment-grade T-Bills that mature at different times in the near future. This latter point is where T-Bill ladders differ from the bond ladder strategy, which focuses on purchasing bank certificates of deposits (CDs) or bonds with longer maturities.
Is there a downside to T-bills? ›
T-bills pay a fixed rate of interest, which can provide a stable income. However, if interest rates rise, existing T-bills fall out of favor since their return is less than the market. T-bills have interest rate risk, which means there is a risk that existing bondholders might lose out on higher rates in the future.
Should you invest in Treasury bills during recession? ›
During a recession, investing in cash and cash equivalents becomes a strategic choice for investors who are hoping to preserve their capital and maintain liquidity. Cash equivalents include short-term, highly liquid assets with minimal risk, such as Treasury bills, money market funds and certificates of deposit.
Why would anyone bother investing in Treasury bills? ›
Treasury securities are considered the safest and most liquid investment. This makes Treasuries the perfect collateral for borrowing money.
Why ladder T bills? ›
By building a Treasury Bill ladder, if interest rates go up in three months, by then, your three-month Treasury Bill will mature, then you can use that proceeds to buy a higher-yielding Treasury Bill.
What is the best length for a bond ladder? ›
Generally speaking, you should aim to have at least 10 "rungs" in your bond ladder. All things equal, the more rungs in the ladder, the higher the diversification, liquidity, and yield stability.
Should I do a bond ladder? ›
If you want to generate income after you have retired or while you are transitioning away from full-time work, building a ladder of individual bonds could offer reliable income, preserve the value of your portfolio, and give you peace of mind well into the future.
Choosing between a CD and Treasuries depends on how long of a term you want. For terms of one to six months, as well as 10 years, rates are close enough that Treasuries are the better pick. For terms of one to five years, CDs are currently paying more, and it's a large enough difference to give them the edge.
Should you'T-bill and chill? ›
The “T-bill and chill” strategy might pay off over some shorter-term periods (as it has over the past 12 months), but it's not a reliable way to build long-term wealth.
Why is a bond ladder better than a bond fund? ›
Bond Ladders
Rather than buying bonds with the same maturity date, you can stagger the purchase of bonds at different maturity dates to generate more consistent cash flow and reduce interest rate risk.
Why people don t invest in Treasury bill? ›
The biggest downside of investing in T-bills is that you're going to get a lower rate of return compared to other investments, such as certificates of deposit, money market funds, corporate bonds or stocks. If you're looking to make some serious gains in your portfolio, T-bills aren't going to cut it.
How do you avoid tax on treasury bonds? ›
The Treasury gives you two options:
- Report interest each year and pay taxes on it annually.
- Defer reporting interest until you redeem the bonds or give up ownership of the bond and it's reissued or the bond is no longer earning interest because it's matured.
Treasury bonds, notes, or bills sold before their maturity date could mean a loss, depending on bond prices at the time of the sale. Simply put, the face value is only guaranteed if the Treasury is held until maturity.
What is the best way to invest in Treasury bills? ›
Where to buy Treasury bonds, notes or bills. While you can buy Treasurys like T-bonds directly from the source — the U.S. government — one of the most common ways people add them to their portfolio is by investing in Treasury exchange-traded funds or mutual funds through bank, brokerage or retirement accounts.
How to make money off Treasury bills? ›
You buy bills at a discount — a price below par — and profit from the difference at the end of the term. While T-bills don't pay interest like other Treasurys, the difference between your discounted price and the par value is essentially the "interest" earned.
Is it better to buy a CD or a Treasury bill? ›
Choosing between a CD and Treasuries depends on how long of a term you want. For terms of one to six months, as well as 10 years, rates are close enough that Treasuries are the better pick. For terms of one to five years, CDs are currently paying more, and it's a large enough difference to give them the edge.
How much will I make on a 3 month treasury bill? ›
3 Month Treasury Bill Rate is at 5.25%, compared to 5.25% the previous market day and 5.10% last year. This is higher than the long term average of 4.19%.
