What is a Treasury Bill Ladder?

The U.S. government issues short-term debt securities known as Treasury bills. They have terms ranging from 4 to 52 weeks and are sold at a discount from their face value. Treasury bills are a safe investment option, highly liquid, carry low risk of interest rate fluctuations and offer tax benefits. 

If you are looking for a flexible and secure investment option, consider a Treasury bill ladder. A Treasury bill ladder is an investment strategy of holding several Treasury bills with different maturity dates. 

Discover how a Treasury bill ladder works and the steps you can take to create your ladder.

Understanding Treasury Bills

Treasury bills (T-bills) are short-term debt securities issued by the U.S. government. They are widely regarded as one of the world's safest investments and offer maturities ranging from 4 to 52 weeks. T-bills are often sold at a discount to their face value and when they mature, you receive the full value despite purchasing them at a discount. 

Your earned interest is the difference between the face value and the purchase price. T-bills appeal to investors for multiple reasons: they offer high liquidity, are exempt from state and local income taxes, have lower federal income tax rates, low transaction costs and minimal investment requirements. 

They're also helpful for portfolio diversification, as they often have a low correlation with other asset classes – they can perform well when other investments are doing poorly.

How a Treasury Bill Ladder Works

A popular investing strategy, a Treasury bill ladder is easy to create and will generate steady income for you. The idea is to buy and hold multiple securities with different maturity dates. This will create a ladder-like structure. Each rung in the ladder is formed by buying T-bills with different maturities. 

At the time of maturity, you receive the face value and interest income which you then reinvest in another T-bill with the longest maturity in the ladder to maintain its structure and length. You can continue repeating this process until you achieve your investment goals or decide to liquidate the ladder. 

Building a Treasury Bill Ladder

To build a Treasury bill ladder, you need to consider factors, such as:

• The amount you want to invest
• The length of time you want to invest
• The number of rungs you want in your ladder
• The frequency of principal and interest payments 
• The interest rate environment and your expectations for future changes

Based on these, you need to decide the number of T-bills to buy, the maturities to choose and how much to allocate to each rung. Say, you have $10,000 to invest for one year and you want five rungs in your ladder, you can buy:

• $2,000 worth of 4-week T-bills
• $2,000 worth of 8-week T-bills
• $2,000 worth of 13-week T-bills
• $2,000 worth of 26-week T-bills
• $2,000 worth of 52-week T-bills

This way, you would have an average maturity of 6 months and receive income and principal payments every 4 weeks.

To illustrate how a Treasury bill ladder works in practice, let’s look at a real-life example.

Alex, a beginner investor, buys three sets of T-bills worth $1,000 each with varying maturity terms of 4, 8 and 13 weeks.

Her T-bill ladder looks like this:

Term Interest Rate Amount

4 weeks 2.04% $1000

8 weeks 2.86% $1000

13 weeks 3.54% $1000

After four weeks, her first set of T-bills matures and she reinvests the money in a new set of T-bills with a 13-week term and a higher interest rate of 3.80% APY. Her new T-bill ladder looks like this:

Term Interest Rate Amount

4 weeks 2.86% $1000

9 weeks 3.54% $1000

13 weeks 3.80% $1000

She repeats this process every four weeks, rolling over the matured T-bills into new ones with higher rates. After one year, she would have earned more interest income than she would have earned from a savings account or a CD with the same amount.

Benefits of a Treasury Bill Ladder

A Treasury bill ladder can be beneficial for investors who aim to preserve capital while generating income at minimal risk. 

• Enhanced liquidity and flexibility: In a Treasury bill ladder, you’ll have a steady cash stream that can be used to build an emergency fund, pay bills or explore new investment opportunities. The ladder can be customized to fit your investment goals and preferences by adding or removing rungs or adjusting maturities. 
• Potential for higher returns: It is possible to make the most of changing interest rates by reinvesting the proceeds at higher rates.
• Reduced risk through diversification: Treasury bills are one of the safest investments. They are government-backed, low-risk securities that have little chance of default. They tend to negatively correlate with stocks, performing well during stock market declines. By investing in Treasury bills with varying maturities, it becomes possible to balance the risk/return profile and hedge against inflation. 
• Tax efficiency: You can lower your tax burden with a Treasury bill ladder. It allows you to avoid state and local income taxes while you have to pay lower federal income tax rates on your interest income. You can also defer taxes by holding your T-bills until maturity.

Risks and Considerations

Although a Treasury bill ladder is a relatively safe and straightforward investment strategy, it is not without risks. 

• Opportunity cost: The interest rate on a Treasury bill ladder may not be high enough compared to other investment options like bonds and stocks. In a low-interest environment, you could lose the potential of a higher return on your money.
• Inflation risk: Investing in a Treasury bill ladder may not help combat the effects of inflation. In a high inflationary environment, your money will devalue over time, resulting in a negative real return on your investment if the interest rates do not keep pace with inflation. 

Comparison with Other Investment Strategies

A Treasury bill ladder is one of many investment strategies you can use to achieve your financial goals. Here’s how it stacks up against other options:

• Certificate of deposit (CD) ladder: A CD ladder works like a Treasury bill ladder and the only difference lies in buying and holding multiple CDs with varying maturity dates. CDs pay a fixed interest rate and are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor per bank. However, they offer higher interest rates than T-bills but have high early withdrawal penalties. CDs are subject to state and local income taxes. 
• Bond ladder: As the name suggests, a bond ladder strategy involves buying multiple bonds with different maturity dates. They also offer a higher interest rate than T-bills but come with higher credit risk and price volatility. 

The right investment strategy will depend on your goals, risk appetite, investment horizon, tax situation and interest rates. For the short-term, a T-bill ladder can provide a secure, flexible and high-yield option while guarding against inflation. It helps to weigh the costs, taxes and management expenses that come with building a ladder. 

It is an ideal approach for risk-averse investors who seek tax advantages and stability. While it may not provide the same level of returns as other riskier investments, it will keep your capital safe. 

Frequently Asked Questions