The purpose of this thread is to share infomation and provide a comparison among the various debt instruments that the Department of the Treasury offers to individuals. The focus of this thread shall be the following:

1. Pros and cons of non-marketable treasuries (savings bonds) vs. marketable treasuries (bills, notes, bonds, TIPS)
2. Pros and cons of inflation-adjusted treasuries (I bonds, TIPS) vs. fixed rate treasuries (EE bonds, bills, notes, bonds)
3. Share information on TIPS
4. Share information on derivatives/funds issued by other institutions that have treasuries as their underlying investment
5. Strategies and analyses to determine which is the best option for specific cases


Introduction and links to other threads

- Savings bonds come in two varieties: EE bonds (fixed rate) and I bonds (inflation-adjusted). They are non-transferrable and non-marketable. They have been discussed in great detail in the following threads:
Savings Bonds as an investment: a FAQ and info thread (Text Search)
Strategy: Gov't I bonds as a good 11 month investment: 4%+ returns likely (Text Search)

- "Regular" treasuries, the ones with the most $$$ invested in them, are marketable and issued with fixed rate (aka fixed coupon). They are called bills (issued for 1 year or less), notes (issued for 1 to 10 years) or bonds (issued for greater than 10 years). Threads where T-bills and T-notes are discussed:
Treasury Bills: Rate Tracking, Discussion, and FAQs (Text Search)
Treasury Notes: strategies for 2 to 10 year government debt investments (Text Search)


- TIPS, or Treasury Inflation Protected Securities, are marketable, inflation-adjusted, and issued for various fixed terms from 5-20 years. There are some archived threads with limited information:
TIPS: Treasury Inflation Protected Securities
Anyone here invest in TIP's ?


Commonalities among all treasuries

- issued by U.S. Department of the Treasury
- can be purchased in TreasuryDirect
- almost zero default risk
- exempt from state and local taxes

That's where the commonalities end!


Non-marketable (I, EE savings bonds) vs. marketable (bills, notes, bonds, TIPS) treasuries

1. Savings bonds are considered "non-marketable" because they cannot be sold to anyone; they can only be redeemed by the Treasury (or by a bank that acts on behalf of the Treasury). Also, you can only buy them from the Treasury (or a bank). The other treasuries are "marketable" in the sense that you can buy and sell them on the secondary market (brokerage, etc). Even so, they are always issued by the Treasury and at maturity, redeemed at the Treasury by the last owner.

2. The rate for savings bonds is determined by the Treasury and seemingly doesn't always follow market forces. The rate for marketable Treasuries is determined at regular auctions by the bids of auction participants, and does follow market forces. In practice, for treasuries issued at the same time, marketable rates are always higher than savings bond rates (with the exception that savings bond rates use an average over 6 months, so savings bond rates could be higher if the six-months average is higher than the current rate).

3. The value of a savings bond is always principal + accrued interest. The same is true for marketable treasuries IF HELD TO MATURITY. Marketable treasuries bought and sold on the secondary market can have a different value, i.e. price, than the principal, based on market conditions.

4. Savings bonds have certain federal tax advantages (income deferred to redemption, can be tax-exempt when used for education) that marketable treasuries don't have.

5. Savings bonds are issued year round, 24/7 on TreasuryDirect. Marketable treasuries are issued at specific times at auction. Some of them (bills) are sold in one week intervals, others (especially TIPS) only a few times a year. Already issued marketable treasuries can of course be purchased every day on the secondary market.

6. Savings bonds MUST be held for a minimum of one year. Marketable treasuries can be sold immediately on the secondary market. Bills even have a term to maturity of less than a year. TD imposes a 45-day hold on newly auctioned issues through its system. (still TBD how this applies to selling, and if it's different when bought through a brokerage)

7. Savings bonds CAN be held for up to 30 years and are not callable (i.e. the Treasury cannot force you to redeem them earlier). A 3-month penalty applies in the first 5 years. Marketable treasuries have a defined maturity date at which the principal is repaid (for individuals, 28 days to 30 years); some of the marketable treasuries issued before 1985 are also callable, i.e. the Treasury can choose to repay you principal earlier and not pay you any more interest. Currently auctioned issues are all non-callable.

8. With a savings bond, interest will be added to the principal and compounds. Marketable treasuries pay interest (coupon) in 6-month intervals and principal is returned at maturity. Bills are zero-coupon bonds, meaning principal and interest is paid at maturity.

9. When redeeming a savings bond, you're always guaranteed principal + interest. When selling marketable treasuries, you're only guaranteed principal at maturity. When selling on the secondary market, you might get more or less for your bond, depending on prevailing interest rates for similar maturities. The closer to maturity, the less flucuation.

10. Savings bonds are issued as paper (from banks) or electronic bonds (from TreasuryDirect). Marketable treasuries are only electronic and auctioned through TreasuryDirect, Legacy Treasury Direct, and brokerages.

11. Some mutual funds and ETFs invest in marketable treasuries, but never in savings bonds. Also, derivatives like STRIPS exist for marketable treasuries but not savings bonds.

12. The Treasury issued debt instruments consist to only about 2% as savings bonds and 98% as marketable treasuries.

13. There's a $60,000 cap on savings bonds per year, per person. No such limit exists for marketable treasuries.


Inflation-adjusted (I saving bond, TIPS) vs. fixed rate (EE savings bond, bills, notes, bonds) treasuries

1. Inflation-adjusted bonds consist of a fixed "real" interest rate and an adjustable interest rate which tracks the change in the CPI-U inflation index. For I bonds, the real rate is called the "fixed rate" and for TIPS, "real yield." For I bonds, the two interest components (fixed + inflation) are added to give a total rate that adjusts every 6 months. For TIPS, the principal itself is adjusted based on inflation of the last 2 and 3 months (with a daily published ratio), and the coupon payment is paid on the adjusted principal. The real yield defers from the coupon based on the price of the TIPS at auction. The end result is effectively the same for I-bonds and TIPS in the long run, if they had the same real interest rate.

2. Fixed rate treasuries have a fixed interest payment until maturity. (EEs before 2003 actually had a fluctuating rate.) Inflation can erode their value. However, they had an implied real yield and future inflation expectation when they were issued. If inflation is lower than expected, they will be a better investment than TIPS/I bonds. If inflation is higher than expected, TIPS/I bonds will be better.

3. TIPS secondary market prices can also fluctuate (significantly), if the real yield that investors demand changes.

4. Note that during times of deflation, the I bond rate would go to zero, but never below. Since TIPS principal is adjusted strictily with CPI-U changes, the value of the principal can go down from a peak it's already reached (but never will go below original face value). Since CPI-U fluctuates up and down from month to month this can happen a lot, but is not really a concern if there is an overall upward trend over time. Even with the I-bond, the rate is similarly affected by the ups AND downs of the CPI-U due to the 6-month average, however they will never go down from a value they have previously reached.

(subject to revision and addition as we go along ...)

If you're thoroughly confused I suggest you read or skim the above linked threads first (for savings bonds and T-bills). If you have a specific question, I also provided text search links above. If you can't find the answer, please feel free to ask! Especially questions on TIPS are all game here. I'm looking forward to all your comments, suggestions, experiences, and insights!

Revision History

Rev 1.0: original version (7/22/06)
Rev 1.1: added callable info, TIPS minimum principal, 45-day hold. Thanks DaveHanson, LH2004, RussianInNYC, ThursdaysChild! (7/23/06)
Rev 1.2: corrected name of T-bill thread. Thanks ThursdaysChild! (8/18/06)
Rev 1.3: added T-note thread link. Thanks ThursdaysChild! (8/29/06)

(Credited contributors are listed in alphabetical order)

Bullet Point 7 on "marketable vs non-marketable":

- Regulat treasuries can be callable or not-callable. I think that Treasury stoped issuin callable ones as it has to pay a premiun for that feature.

mariojm said:
6. Savings bonds MUST be held for a minimum of one year. Marketable treasuries can be sold immediately on the secondary market....
The Treasury said (in response to an email query):
Note: Marketable securities can be transferred or sold beginning 45 days after issue.
(name)
Customer Service Specialist

Many thanks for taking this on mario!

Note that since 1985, all treasury bonds are not callable. For those who hold long term, this is one major advantage they have over muni bonds, which generally are callable.

Were you thinking of simply keeping this thread factual about the differences, or of also diving into an analysis of which ones were the better buy in which circumstances?

ThursdaysChild said:LH2004 said:ThursdaysChild said:mariojm said:6. Savings bonds MUST be held for a minimum of one year. Marketable treasuries can be sold immediately on the secondary market....The Treasury said (in response to an email query):
Note: Marketable securities can be transferred or sold beginning 45 days after issue.
(name)
Customer Service SpecialistWhat was that in response to?

I don't know if there's some special limitation on Treasury Direct, but huge volumes of Treasuries are bought and then sold seconds later every day.
Perhaps marketable securities bought through brokers can be sold immediately (I've never tried it), but when you buy through TreasuryDirect, you cannot sell immediately through the Treasury's SellDirect feature. I assumed (perhaps wrongly) that the email also meant that when you buy through TreasuryDirect you cannot sell on the secondary market immediately -- again, never tried it. I buy as investor, not trader.

I had always interpreted the 45-day rule to mean Treasuries can't be transferred out of TD (to a broker, etc.) but didn't know they couldn't be sold. So essentially a 28-day bill couldn't be sold at all then before maturity? Does anyone else have any input on this, I'd like to include some info on the 45-day period in the OP.

Updated OP with the new info & started a revision history. We probably ought to think about what to do with quick summary. I'd like to include some of the relevant links to TIPS, TD, market rate infos, etc. Maybe on a better day than one when my windshield was smashed by a rock on the highway!

I think there are 2 major issues each investor needs to decide:

1. Inflation-linked (TIPS/I bonds) vs. nominal (ordinary bills/notes/bonds/EE bonds)
2. Savings bonds (I or EE) vs. marketable securities (TIPS or other bonds, notes or bills)

The third decision, of course, is between Treasuries in general and everything else. I won't address that issue, except to remind you that all Treasuries are free of state and local income taxes, and most regular Treasuries are extraordinarily liquid -- but you pay for both of those, in the form of meaningfully lower yields than other highly safe investments (like, AA-AAA corporate bonds, on which defaults are possible but extremely unlikely), so they may be a bad choice if you don't need those features (for example, because you live in a state without an income tax).

Here are some thoughts on the other 2 issues:

1. I think there is a very strong case for using inflation-linked bonds, at least for long-term investing. Ordinary, fixed-payment bonds just don't have an obvious place in the average person's portfolio. I mean, with bonds in general, you're accepting a much worse expected return than you get from stocks; in return for that, you should be getting safety -- but if there's an outbreak of unexpected inflation, ordinary bonds aren't even safer, in terms of spending power, than stocks. On the other hand, stocks do NOT give very good protection against inflation, either. The way the Treasuries work may not be perfect, but it's much better than any alternative. I think, for a very conservative investor, TIPS or I bonds should be the dominant part of the portfolio.

The downside is, I think we can expect that, in return for that type of safety, inflation-linked bonds will have worse expected performance -- in other words, the implied inflation rates in ordinary bonds will be biased high. So, if you're not very conservative, ordinary bonds can make some sense. But you need to balance that against other places you can "spend" your "risk budget," like stocks, that offer higher returns.

2. Personally, I don't trust savings bonds one bit. I think the entire program exists to let the government get below-market yields out of ordinary citizens, who would be better served with the same securities institutions buy. That's generally reflected in the significantly lower yields of savings bonds -- typically, I bonds yield about 1 percentage point per year less than long-term TIPS. That's a huge amount to give up.

Savings bonds USED to be much easier to buy and sell in small quantities. But that's changing, including because of Treasury Direct.

Savings bonds do have tax advantages. But, in general, those advantages won't be good enough: if you're in a high bracket, you'll be better off with tax-free municipal bonds, after you've taken the primary steps of putting your bonds in your IRA or 401(k) to the extent you have room. If you're in a low bracket, the ability to defer income isn't worth much to you. The ability to cash in savings bonds tax-free for educational expenses is limited to the lower brackets.

Savings bonds can make sense from a tax perspective for people who are in a high bracket now, but will cash out when retired and in a much lower bracket.

Savings bonds have a built-in positive option feature: you can cash them in early and pay a pre-set penalty, whereas, with ordinary Treasuries, you get whatever the market value is. But I don't think that's worth very much: if rates have fallen, you'll still pay the penalty, while, with real treasuries, you'd get MORE than face. So the right solution typically will be to buy ordinary treasuries of a duration that make sense to you. If you buy savings bonds, you're paying for an option feature which you may not need, and which you'll have a hard time valuing in general; you really need to know what you're doing to conclude it's an attractive value.

Yeah, what LH2004 just said. (only read his reply after I posted mine just now)

Good point that the first decisions, before you ever get the TIPS vs. I-bonds, have to be:
a. do I really need almost zero risk? do the state/local tax advantages help me?
b. do I want to forgo the "interest rate risk premium" of fixed-rate treasuries for the safety of inflation adjustment?

Fixed rate bonds are made up of these components: real rate of return + expected inflation rate to maturity + default risk premium + interest rate risk premium

Inflation adjusted bonds of these: real rate of return + actual inflation rate + default risk premium

In the case of Treasuries, as opposed to corporates, default risk is zero. But you can see that for the feature of having the actual inflation rate adjust the value of your bond, you pay the price of not getting the "interest rate risk premium" that a fixed rate bond gets for taking on the "interest rate risk."

In the end it all comes down to this: if inflation is higher than expected, the TIPS wins; if inflation is lower than expected, the fixed bond wins. If inflation is exactly the same as expected, the fixed bond wins by the margin of the "interest rate risk premium." (I believe this is usually a couple 10 bps.)

LH2004 also made a good point about upside potential. Yes, TIPS can lose money compared to I-bonds, before maturity. But if the real market yields go lower after your purchase, you can sell at a premium.

ThursdaysChild said:When we get to the analysis of state tax implications, we need to take tax brackets into consideration rather than, or in addition to, top tax rates.
Example: here in California, the top rate is 9.3%, but that's 9.3% of the amount over $41,486. In Oregon the top rate is "only" 9.0%, but that's 9.0% of the amount over $6650. So wouldn't Treasuries be a better deal for Oregonians than for Californians?

Well, much thinking and background debating with Mr. Engineer led me to the conclusion that it's the marginal rate that you should consider. If you're in California and your Treasury-alternative investment is the 41,487th dollar it's just as good as if it's the 1,000,000th dollar. To summarize, if your state taxable income puts you into the 9.3% bracket, it's just as good as an Oregonian (is that what they call them?) with the same income. Now, if you had lower income in CA that doesn't put you in 9.3% but would put you in 9.0% in Oregon, then yes you have an advantage in Oregon. I guess the sweeping generaliation is that folks in CA have > 41,486 income and are in 9.3% bracket. (Which probably is not a bad assumption, I have yet to meet a Californian making less than me!)

I've gotten a PM with a similar case in NY. They have state taxes, and also city taxes in NYC, with various tax bracket cutoffs all over the place, up into the $100k's so generalizing for the NY folks is much more difficult.

EDIT: ThursdaysChild, correct at smaller incomes, the analysis is different, in the sense that people are not in the highest marginal tax bracket for their state. But I see this no different than folks in 10% federal vs. 33% federal bracket, where the 10% folks don't have an advantage with munis and the 33% folks do, for instance.

But the important point you raise is that the conventional wisdom that CA residents benefit more than others, doesn't count for people with low incomes. (or students with low incomes, etc) I completely agree with that. Everyone should check what their marginal rate is and not trust our generalization.