What Are Treasuries?

How Do Treasuries Work?

The US Treasury Department conducts auctions to sell these securities to investors, who essentially lend money to the government. In return, investors receive regular interest payments and get their initial investment back when the security reaches maturity.

By purchasing Treasuries, investors contribute funds to the government to support its various activities, such as infrastructure projects and social programs. The government uses the proceeds from selling Treasuries to finance its operations, pay existing debt interest, and manage its fiscal needs.

Treasuries are considered a low-risk investment because the US government has a reputation for being highly creditworthy and is unlikely to default on its debt obligations. These securities are often sought after as a safe haven during times of market volatility or economic uncertainty. Institutional investors and central banks frequently utilize Treasuries to manage risk and maintain liquidity in their portfolios.

A significant advantage of Treasuries is their high liquidity. They can be easily bought and sold in secondary markets, providing investors with flexibility and the ability to quickly convert their holdings into cash if needed.

Types of Treasuries

There are several types of US Treasury securities:

1. Treasury Bills (T-bills): T-bills are short-term securities with maturities of one year or less. They are typically offered in durations ranging from a few days to 52 weeks. Sold at a discount to their face value, T-bills do not pay interest but are redeemed at their full value at maturity.

2. Treasury Notes (T-notes): T-notes are medium-term securities with maturities between 2 and 10 years. They pay a fixed interest rate every six months and are sold at face value.

3. Treasury Bonds (T-bonds): T-bonds are long-term securities with maturities from 10 to 30 years. Like T-notes, they pay a fixed interest rate every six months and are sold at face value.

4. Treasury Inflation-Protected Securities (TIPS): TIPS are inflation-indexed securities where both principal and interest payments adjust based on changes in the Consumer Price Index (CPI). They pay a fixed interest rate every six months and are sold at face value.

5. Floating Rate Notes (FRNs): FRNs are securities with variable interest rates that reset periodically according to a specified index, such as the 3-month LIBOR rate.

6. Cash Management Bills (CMBs): CMBs are short-term securities issued as needed to meet the US government's short-term cash requirements. They have maturities of less than one year and are sold at a discount to their face value.

7. Strips: Strips are zero-coupon bonds created by separating the principal and interest payments of a Treasury security into separate securities. They are sold at a discount to their face value and do not pay interest.

8. I Bonds: I Bonds are Treasury securities available for individual investors. Like other Treasuries, they are backed by the US government's creditworthiness, but they also feature inflation protection. The value of I Bonds increases when inflation rises. Although considered a safe investment, there is still some risk involved.

Difference Between Treasuries and Stocks

Indeed, stocks and Treasuries are distinct investment options that operate differently and have varying risk profiles. Here are some important contrasts between stocks and Treasuries:

Ownership: Stocks grant partial ownership in a company, offering the potential for capital gains and dividends. Treasuries involve lending money to the US government and receiving regular interest payments.

Risk: Stocks are generally considered riskier due to price volatility based on market conditions, economic factors, and company-specific news. Treasuries, conversely, are among the safest investments as they are backed by the full faith and credit of the US government.

Return: Stocks have the potential for higher long-term returns through company growth and stock value appreciation. However, stocks also come with the risk of substantial losses. Treasuries offer guaranteed returns at a fixed rate.

Liquidity: Stocks are generally more liquid, enabling quicker buying and selling. Treasuries, especially those with longer maturities, have lower liquidity.

Purpose: Stocks are often used for long-term wealth growth and achieving financial goals, while Treasuries are frequently employed for capital preservation and generating a reliable income stream.

Taxes: Both investments have specific tax implications, but Treasuries are generally considered more tax-efficient, as their income is often exempt from certain state and local taxes.

Individuals should consider their risk tolerance, investment objectives, and financial circumstances when deciding whether to invest in stocks, Treasuries, or both.

The Bottom Line

In summary, Treasuries can play a crucial role in an investment portfolio by offering stability, consistent income, and diversification. They are especially suitable for investors seeking safety and reliability, or for those looking to balance out higher-risk investments in their portfolio.