Recently, on her eponymous podcast, Suze Orman raised the issue of Treasury bills (T-bills) and Treasury notes (T-notes). Orman views both as a way to ensure a guaranteed rate of return in topsy-turvy times.
Why does that matter?
Orman is a big believer in adapting to current circumstances, and because no one knows precisely what the market will do over the next few years, she suggests people consider some safe investments. That way, they know their money is growing but safe.
While Orman says she doesn’t think it’s the right time to buy long-term treasury bonds, “I would be buying Treasury bills at three months or six months or notes at one year, two year, or three years.
- T-bills are short-term debt obligations, backed by the Treasury Department. What makes T-bills particularly attractive to some is that they have a maturity of one year or less.
- Treasury notes (T-notes) are also government-backed financial instruments. They mature in two to 10 years, with an interest rate that does not change over the life of the loan.
Building a Treasury ladder
Building a Treasury ladder involves spreading your money. Let’s say you have $5,000 you want to invest. You put $1,000 into a three-month T-bill and $1,000 into a one-year T-bill paying a higher interest rate. You put another $1,000 into a two-year T-bill paying an even higher interest rate. The final $2,000 is invested in a three-year T-note.
In three months, when the first bill has matured, you take a look at the current interest rate to determine whether it’s on the way up or down. If rates are increasing, you reinvest that $1,000 (plus the interest you’ve earned) into another T-bill or T-note. If the rates are tumbling, you stop for now.
The idea is to take advantage of interest rates as they rise, allowing money to mature at different times. The longer you invest the money, the higher the interest rate earned.
A hedge against loss
It’s easy to be dazzled by the high rates of growth that attract investors to the stock market. Orman made it a point to remind her listening audience that there’s a difference between interest rate and average annual rate of return. It’s average annual rate of return that’s important because that’s the amount of money an investment is worth after time.
Interest rate is the amount you earn on an investment for a set period. Average annual rate of return is the amount you earn over time after factoring in all gains and losses.
Say you invest $10,000 and it earns 40% in one year. That’s $4,000 in interest, making your investment worth $14,000. It’s extremely impressive.
The next year, the investment drops by 25%, meaning it loses $3,500 in value. That leaves your investment worth $10,500.
Your average annual rate of return is 2.5% ($10,500/$10,000 = 0.5/2 years ).
By building a Treasury ladder, you know from the jump how much money you’re going to earn on the investment and can plan accordingly.
The future is unpredictable
Orman sees Treasury bills and notes as a way to hedge against the expected highs and lows of the stock market. She never suggests a person put all their money into government-backed investments, but does think it’s wise to make sure a slice of their portfolio is guaranteed.
Treasury bills and notes can be purchased through Treasurydirect.gov or through a brokerage firm.
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