Using TreasuryDirect for Conservative Investing

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Over the last few days, with all the tumult on Wall Street (AIG and Merrill and Lehman, oh my!), several people have written to me expressing deep personal concern about investing in the stock market. They see a 25% dip in the value of the market this year and hear a lot of apocalyptic talk and they’re rightfully concerned about investing in the stock market.

Lucas put it best:

After paying off all my debt, I had planned on following in your footsteps and open an account at Vanguard and invest some of my extra money there, but the stock market really scares me and with banks failing I don’t feel safe putting my money there. What else should I be doing with it?

First of all, the down market doesn’t concern me all that much. In fact, on Monday at the end of the day (after that 500 point loss in the Dow Jones Industrial Average), I maxed out my Roth IRA contributions for the year. My belief is that you can’t actually predict where the stock market will bottom out, but it’s pretty clearly much lower than it was at the start of the year – I’m essentially getting the same index fund I would have bought back in January at a 25% discount.

That doesn’t change the fact that many people simply don’t have that kind of risk tolerance, and if you’re in that boat, your investments should be as conservative as possible – a mix of cash (in savings accounts) and treasury securities.

The U.S. Department of the Treasury by drstout on Flickr!Treasury securities? I discussed treasury securities in the past, but here’s a summary for those who want a quick refresher. Treasury securities are investments that are backed by the federal government. In essence, a treasury security is a small portion of the national debt – the government issues them so that they can have cash on hand to pay the bills with the intent of repaying that debt (to you) at a later date. If you’ve ever watched CNBC or read Money Magazine and heard mention of treasury notes, treasury bills, treasury bonds, or TIPS, those are all different flavors of treasury securities – here’s more detail about each one. You can also buy good old fashioned savings bonds if you prefer – Series I bonds are matched to inflation.

What are the advantages? First of all, treasury securities (at least those that have a lifespan of a year or more) usually have a fixed rate of return (known as the coupon rate). Let’s say you buy a treasury note with a face value of $10,000 and a coupon rate of 4.5%. Every year, you’ll receive $450 in payments from the federal government (they issue payments every six months, so you’ll receive a payment of $225 every six months). When the note expires, you get $10,000. Treasury securities are a great way to lock in a decent rate on your investment.

One interesting facet of this is that you don’t always necessarily pay a fixed price for the investment – they’re auctioned off by the federal government (don’t worry – this is easy for you to do), so sometimes you might be able to buy a $10,000 investment for $9,800 and other times it might be $10,200 – either way, you’ll get $10,000 at the end. Here’s a link to current auction results on those items. For example, a recent auction on ten year treasury notes (issued on September 15, 2008 and maturing on August 15, 2018) had a interest rate of 4%, but those treasury notes sold for $103.07 per $100 of face value. That means the note itself will actually only yield 3.628% per year.

But there’s an even better benefit – earnings treasury securities are exempt from state and local taxes. In Iowa where I live, that’s actually fairly substantial, as the higher state tax brackets are at 8% and 9%, respectively. Thus, compared to just keeping the money in a CD or a savings account, I get to keep a larger portion of the return on treasury securities.

It’s also worth nothing that treasury securities are very flexible. They’re available at pretty much any price you want (in increments of $100) and have vastly different time constraints, from 28 days (treasury bills, which have a lifetime shorter than a year, don’t issue coupon payments – instead, they just sell for a few percent less than their face value) to 30 years (obviously, the longer term ones pay better). Once you’ve bought one, though, the coupon rate (for longer-term notes and bills) is locked in and the value is backed by the government, so you just sit and collect the proceeds.

Also, one investment option available to you if you invest in treasury securities are TIPS – treasury inflation-protected securities. When you buy one of these, you get a very low “coupon rate” (usually 1-2%), but the value of the treasury is adjusted upwards at the rate of inflation. So, for example, let’s say you bought a $10,000 TIPS for two years with a 2% coupon rate, and each year inflation was marked at 6%. Your first year, you’d get $200 in interest payments, then the security would adjust up to be worth $10,600. The second year, you’d get $212 in payments, then the security would adjust up to $11,236, which is what you’d get back at the end of the second year. So, your total return on that $10,000 investment would be $1,648 – just below an 8% return. Obviously, this investment is based on what inflation does – if inflation is very low (or if there’s deflation happening), it’s a pretty awful investment.

What are the disadvantages? Compared to other investments, your rate of return is usually pretty low. It usually varies between 2 and 6% in returns, depending on a huge number of factors. Before diving in, you should make sure that you won’t get a better return just keeping your money in a high-yield savings account (remembering, of course, that such accounts do cause you to pay state and local taxes on the interest, while treasury securities do not).

In short, if you’re a very conservative investor who wants to stay out of the stock market, treasuries are a great (and simple) way to go. The best part is, as an individual investor, the federal government makes it very easy to get started.

TreasuryDirect Getting started in investing in treasury securities is actually really easy. The federal government has a website, TreasuryDirect, that makes it incredibly easy to invest.

The signup process is pretty painless, taking only about five minutes or so. The biggest annoyance is that you have to wait for the government to mail you an “access card,” which basically is their method of verifying your mailing address so that they can be sure who you are.

Once you’re in, you link your checking (or savings) account to your TreasuryDirect account. You then pull in the money you need from your bank (they call this buying a “certificate of indebtedness”, but it basically just means you’re holding some money in your TreasuryDirect account) and start buying. You have to invest a minimum of $100 if you’re buying treasury notes, bills, or bonds, and a minimum of $25 if you’re buying savings bonds. The procedure is pretty straightforward for each of them – place an order, wait for the next auction, then hold those treasuries and have the returns swept into your checking account. This is exactly how one of my friends does it – he has a substantial amount of treasury investments, enough to live off the coupon payments.

So, here’s what you need to know;

Treasury securities are extremely stable investments backed by the federal government. They return a very steady guaranteed rate and you don’t have to pay state or local taxes on the returns, though the rates of return are very low and are often comparable to what you can get in a savings account or a CD. Be sure to compare the rates before you invest in either one. Treasury investments exist for almost any term you’d like, from 28 days to 30 years with lots of increments in between.

If you do decide to go for it, actually investing in treasury securities is quite easy. Just use TreasuryDirect.gov – sign up for an account, link that account to your checking account, and invest away. Since it’s linked to your checking, you can just sweep the proceeds right back into your checking account.

Good luck!

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37 thoughts on “Using TreasuryDirect for Conservative Investing

  1. I’m glad that you mentioned that people hav ea different appetite for risk.
    I’m in the same boat as you – I’m buying high quality dividend stocks and dividend paying ETF’s like DVY. The more of these that I can buy now with 4.5%+ dividend yields, the more dividends are re-invested over time and the earlier I can retire and live off of the dividend income (without touching the principal).

  2. Thank you, thank you, thank you for publicly acknowledging that now is the *perfect* time to be investing in the stock market. If one more blogger (or commenter) shows their utter ignorance by proclaiming that the current market can’t be trusted and they’ve sold off all their stock until a turnaround, I’ll scream.

    Buy low, sell high — this market is a gift to those of us smart enough to keep a little cash on hand.

  3. Everyone has a different appetite for risk. However, there are many different kinds of risk. Avoiding the risk of stock market volatility by choosing a very conservative portfolio can dramatically increase the risk that one will not be able to save enough for retirement. Treasuries can be great investments, but if they are all you invest in, in order to have enough money to retire you will likely need to invest two to three times what you would have needed in a well diversified portfolio with exposure to the stock market.

    RDS
    http://financialvalues.blogspot.com/

  4. “they’ve sold off all their stock until a turnaround”

    A person that’s done that right now has done nothing more than guarantee themselves a 25% loss.

  5. I too purchased ETFs right after that 500 point drop. Since they are in my retirement plan, I wasn’t at all concerned about if things will continue to drop because I have another 30 years or so before I retire.

  6. I-Bonds are better than TIPS for tax deferral. (With TIPS, you pay tax on each yearly adjustment.) The problem right now is that the fixed component of the I-Bond interest rate is 0% which is not good. The rates will be adjusted November 1 and I would wait until then before making a move.

  7. The rate on Treasury bonds has dropped to incredibly low levels, meaning little or no return. The money is as safe as the federal government, but it’s not all that far from putting it under your mattress.

    A high-yield savings account, backed by the FDIC, is going to deliver a better rate of return and be equally safe right now, plus offer far greater liquidity.

    As for me, I’m debating whether to take the money I’ve saved for a down payment on a house and use it to beef up my stock portfolio instead. Like others here, I think this is a remarkable opportunity to do some serious value investing. In the short term it won’t be pretty, but in the long term (3+ years) there’s a lot of money to be made.

    As my dad used to say, “fortune favors the brave.”

  8. You mentioned in a couple of places about the investment being “locked in,” but you never made it a real point. I think it’s important to emphasize that if you put in $10k for 10 years in one of these things, you’re not going to see that $10k again until the decade passes– you can’t do anything with that money, because it’s gone (until it comes back after the 10-year period).

    This is worth emphasizing since Treasury securities are becoming a more and more attractive option for many people like me that had some money in online savings accounts (i.e. HSBC, ING, etc.) who have seen their yeild on those account drop below 3%.

    However, while the returns on Treasury securities are now pretty competitive with the return of some of those accounts I mentioned, especially after factoring in the tax benefits, it may be worth staying put in those accounts and staying away from Treasury securities if investment liquidity is important to you. After all, unless you have a comfortable financial buffer, you never know if you might need that $10k at some point over the next decade (house damage, braces for kid, hairplugs)– if you do, then you’re out of luck, because you can’t go get it like you could with a savings account.

    It may be worth paying a premium for asset liquidity, and I thought it would be worth emphasizing in an article like this. Otherwise, though, great post!

  9. I use TreasuryDirect. It’s a great service. I was investing a *portion* of my savings in I-Bonds, but since I’m seeking return above inflation, I suspended that until the fixed rate goes above 0% (in the meanwhile, I’m enjoying a nice combined return of over 6% on my previous purchases).

    I think treasury instruments are a great thing to have in your portfolio, but contrary to what most people seem to be doing, now is exactly the wrong time to be making new investments in them, since they’re returning basically nothing (and it’s a good time to be moving more funds into equities, while they’re on sale).

    I’m sitting tight on my treasuries and plowing more into index funds.

  10. Interesting post. I haven’t invested in the stock market yet so truthfully I don’t care. I am more focused of investing my money back into my business and my website so I can generate a solid income

  11. Rocky,

    To use Treasurydirect you have to be a US citizen.

    I’m sure foreigners can buy US treasuries. You can probably by them via a broker.

    Jim

  12. Treasury Direct is a good way to invest in treasuries. The problem is with investing in treasuries. Unless you have a defined target date when you need that money and it is within two years you are better off taking some risk if you are in an accumulation phase. With treasuries you get no benefit of a dollar drop (and with our current account deficit there WILL be a dollar drop), you get no benefit of growth in emerging markets (yes, forecasted growth is now 9% and not 10%), you get no benefit of entrepreneurial synergies and you get no benefit of the steps businesses can take to make money in an inflationary environment. What you do get is the negative consequences of declining bond prices as interest rates rise from their very low current levels as the U.S. surely raises rates to moderate the dollar drop.

  13. “they’ve sold off all their stock until a turnaround”

    A person that’s done that right now has done nothing more than guarantee themselves a 25% loss.

    Trent, you are wrong. Lets say you buy a stock for $100 a share. The stock market starts going down. you sell the share for only $80 dollars. The stock market goes down again, and you buy the stock back at $60 dollars. The stock market then rises again and the stock is worth $140 a share. You end uo making $60 bucks instead of $40.

  14. TreasuryDirect is a good low-cost way to invest money that you intend to hold to maturity, but if you need to safely park money for a shorter duration (e.g. working on the down payment for a house that you want to use within five years), you should consider a low-cost Treasury mutual fund (e.g Vanguard) or Treasury SPDR ETFs. There are short, intermediate, and long-term versions of the Treasury funds and ETFs.

    That way, you can benefit from the higher yields on the longer-term bonds without being locked into holding the bonds until maturity, or restricting your investment to the shorter-term Treasuries which normally have lower yields.

    The Treasury funds and ETFs also have a range of maturities and yields within the funds, so you are reducing a bit of risk as compared to buying one bond with a specific yield.

    Of course, the mutual fund approach requires a larger minimum investment (currently $3000 for Vanguard), but subsequent investments won’t incur fees if you buy directly from the mutual fund company. ETFs are traded the same as stocks, so you pay a brokerage fee for each purchase and redemption.

    If you’re doing periodic investments (e.g. putting away $100/month), an automatic investment plan with Vanguard is the way to go if you can get the minimum investment saved up. Vanguard’s current minimum for periodic investments is $100, you can choose monthly, quarterly, whatever frequency works for your budget.

    Periodic investments also work in favor of the investor because of dollar-cost averaging. Much better than investing a chunk of money all at once.

  15. Jim “To use Treasurydirect you have to be a US citizen” : does one has to be a US citizen or a US resident, though a foreign national residing in the US? (viz., employment visa, Permanent resident card, … )

  16. This actually clears up a great deal of confusion for me! Thank you.

    Although I think you might have at one point said, “It is worth nothing,” when you meant, “It is worth noting…”

  17. Great article and very informative. I think Treasuries sound like a great option for retired folks these days. As for me, I am enthused about buying more shares of my mutual funds while they are relatively low, with a preference to small caps, since historically they tend to lead the coming bull market.

  18. Dumb question: Can an individual have more than one Roth IRA–one under American Funds and one under Vanguard?

  19. stock advice – anyone selling now & waiting for a turnaround isn’t going to be savvy enough to buy that stock back at $60, they’ll most likely wait until it’s up close or over what they sold it for and gain nothing.

    I’m debating whether to buy more index fund now or keep the money in savings for the new house fund.

  20. “Trent, you are wrong. Lets say you buy a stock for $100 a share. The stock market starts going down. you sell the share for only $80 dollars. The stock market goes down again, and you buy the stock back at $60 dollars. The stock market then rises again and the stock is worth $140 a share. You end uo making $60 bucks instead of $40.”

    In either scenario, you had to start with $100, and you finished with $140. Either way your return is $40. The only way selling at $60 and buying at $40 could be advantageous is if you invested in something else while the stock was dropping down to $40. That investment would then have to return more than any fees you incurred from buying and selling, rather than just holding the investment. You also would need to consider the tax implications of selling and then re-buying the stock in the middle.

  21. beloml – you can have as many Roth accounts as you want, but you can only fund $5,000 total this year. So you could do $2,500 to each or any other split you want.

  22. I would have given this same advice until this week. But now, with the Fed bailing out everybody and their dog, I’m no longer as confident about securities backed by the Fed. They (we taxpayers) cannot afford to back everyone.

    I’m making sure all my bank accounts are with banks that have a low chance of failure, and I feel fairly confident investing in stocks that having nothing to do with housing, especially now that prices have come down into more reasonable territory.

    I feel the best way to be safe is to not put all your eggs in one basket. Diversify as much as possible. There’s more than stocks, treasury bills/bonds and cash. I wish I knew of a lot more options, but I only know of a few: paying off debt, buying a house to live in, buying additional real estate or REITs, and buying extra staple goods such as canned goods and classic-style clothing.

    There’s also putting some in your mattress (some cash on hand is actually good for emergencies involving city-wide electrical problems, for example.) There’s also investing in tools that help you need less money later such as solar panels, clotheslines, manual tools (like can openers and mixers you don’t need to plug in), hair cutting supplies, and supplies for cooking your favorite foods. (Note that buying staples and tools is also risky because they could get ruined and because you might change your mind about what you like as you go through life or as more options become available.)

  23. It’s worth noting that you can buy bonds with a credit card (up to $1000 per transaction, so if you want $3000 worth of bonds you do it in three transactions). Obviously you’ll want to pay the credit card off right away, or you lose on the interest. But if you pay with a frequent-flyer-miles credit card, you can accumulate a lot of FF miles from saving, rather than spending, money. That’s a good deal.

  24. I checked out the Treasury Direct site. To use it, you must have a SSN or TIN (taxpayer identification number) for the IRS, a US postal address and a US bank account. Thus it appears that most legal residents of the US are eligible.

  25. Yes it does look like a US resident can also get an account.

    The full TreasuryDirect FAQ :
    http://www.treasurydirect.gov/indiv/help/TDHelp/faq.htm
    “In order to open a TreasuryDirect account, you must be a U.S. citizen, resident, or individual who is at least 18 years old with a valid U.S. Social Security Number. You must also have a U.S. address of record and an account at a U.S. depository financial institution that will accept debits and credits using the Automated Clearing House method of payment. We do not currently permit a legal representative, legal guardian, or trustee to establish an account on behalf of an estate, decedent, trust, or incompetent person. “U.S. person” as referred to in the Online Application refers to a person eligible to open a TreasuryDirect account.”

    Jim

  26. I moved the funds in my Vanguard prime money market account to my online savings account. This is a risk management move on my part (get FDIC insurance on my funds) due to all the financial market and institutional turmoil. Also getting 3% at ING (you can get more elsewhere) rather then the sub 1% treasury rates – 2% to 6% is nowhere to be found in this market.

  27. If memory serves me, wasn’t this the method of investing outlined by Dominguez in Your Money or Your Life. It was the early 90′s, and I think at the time rates were a bit higher, but essentially creating a lifetime of investment returns by laddering these notes seemed to be a safe alternative to investing in the market.

    I agree with others that this market is on sale, and I am ramping up my own investments a bit!

  28. When you sell the stock share at $80 and buy it back at $60, you make an extra $20 bucks than never selling it at all.

  29. Reply to Benzta Comment #8
    If you need the $10K before the bond matures you can sell it at the Treasury Direct website.
    The Following is from Treasurydirect.gov.

    To sell a bond before maturity, log in to your account and choose the Sell Direct function. Provide the information the system requests. The request is sent to the Federal Reserve Bank of Chicago which, acting on the Treasury Department’s behalf, will offer your bond to different brokers and sell it to the highest bidder. We then deposit the sale proceeds – less a $45 fee – into the bank account you have designated.”

  30. As much as I like the idea of being conservative, most people can’t afford to be that way unless you already have enough money. Conservative returns will get you conservative results. You may sleep better at nights and if that works, great – stick with it. But before you jump in, realize that it will be a lot tougher for you to generate enough return over your investing lifetime with conservative investments.

    Investment Return Years Outcome
    $10,000 3% 30 $24,568
    $10,000 5% 30 $44,677
    $10,000 8% 30 $109,357
    $10,000 12% 30 $359,496

    All the best… cheaplee

  31. You posted this recommendation of Treasuries on Sept. 18.

    On Sept. 17 yields on 3 month T bills (^IRX) hit .01%.

    The risk free rate was competing directly with the underside of your mattress.

    Good investment advice! pfft

  32. Faculties mentioned that “bonds” can be purchased by credit card. The Treasury (at least through TreasuryDirect) eliminated the option in December, 2003. I can’t find a credit card purchase option on any of the other IOUs sold by the government, unless it is hidden within “Legacy TreasuryDirect”.

    If you’re able to find a broker somewhere that will honor credit cards for purchases of government debt, more power to you. I have yet to find a financial institution that is willing to make purchases that way.

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