I invest my short-term money in a Vanguard money market fund and Treasury Bills. There are many great posts by other bloggers about purchasing T-Bills. I’m not going to repeat the topic. See posts by Jonathan, Ricemutt and Sun.
Earlier this year, I also tested water with Agency bonds for slightly higher yield over Treasury for the same maturity. Agency bonds are bonds issued by a federal government agency or a Government Sponsored Enterprise (GSE). A GSE is a entity not officially part of the federal government but created by laws enacted by Congress. Although most Agency/GSE bonds don’t have the guarantee by the full faith and credit of the U.S. Treasury, they are still rated AAA. You get a slightly higher yield for taking slightly higher risk. Some of the Agency/GSE bonds enjoy the same state income tax exemption as Treasurys. Since I live in a state with high state income tax, I only buy bonds from these issuers, namely
because the interest on their bonds are exempt from state income tax. I avoid bonds from these other issuers because their bonds are fully taxable by the states:
- Federal National Mortgage Association (FNMA or “Fannie Mae”)
- Federal Home Loan Mortgage Corporation (FHLMC or “Freddie Mac”)
- Government National Mortgage Association (GNMA or “Ginnie Mae”)
Fidelity sells new-issue bonds from Federal Home Loan Banks and Federal Farm Credit Banks at face value (“par”) without any commission or fees. Some bonds are callable, meaning that the issuer can pay back the bonds, with interest, sooner than scheduled, but only after a certain date (“call date”). Some bonds are “call protected” which means that the issuer cannot prepay before the bonds mature.
The first GSE bond I bought was a 5-month call protected bond from FHLB. The interest rate was about 0.20% higher than comparable T-Bills. After 5 months, I got paid principal plus interest, just like a CD. Very straight forward. For example today Fidelity has a 6-month call protected FHLB bond at 5.25%. The investment yield on the 6-month Treasury Bills auctioned yesterday was 5.01%. The FHLB bond is 0.24% higher than the comparable Treasury.
The second GSE bond I bought was a 9-year bond from FFCB. It is callable on any day 3 months after the issuance date. It has an interest rate of 5.81% while at the time of the purchase the 10-year Treasury was yielding 4.69% and 3-month Treasury was yielding 5.17%. It looked like a win-win: If it’s called I get higher than the 3-month rate. If it’s not called, I get higher than the 10-year rate. The call date came and went. The bond hasn’t been called yet. I’m still enjoying 5.81% state tax free, until they decide to call it. [Update: see how this bond turned out in How a Callable Bond Worked.]
What’s the catch then? For short term, non-callable GSE bonds, there isn’t much as long as you are willing to hold them to maturity. They usually come in terms between 3 months and 1 year. The minimum purchase is either $5,000 or $10,000, as opposed to $1,000 for T-Bills. I haven’t seen a 28-day GSE bond offered at Fidelity online although someone on Fatwallet Finance said you can buy those by phone with a $200,000 minimum purchase (way out of my league). There’s a slightly higher risk than Treasury but I don’t think it’s material because FHLB and FFCB bonds are AAA rated. For longer term callable GSE bonds, you also have to be willing to hold them for the full term and live with the uncertainty of the call. If the interest rate goes down, they are more likely to call the bonds. You get your money back, plus interest. You just don’t have the higher interest for as long as you wanted. I don’t see it as a big deal either. Interest rate low? Time to move on to something else.
While it’s nice to have a slightly higher yield over Treasury of comparable terms, with the same state income tax exemption, you also have to put things in perspective. Unless a large amount is involved, a 0.24% advantage is not much in dollars. 0.24% on $50,000 is $120 a year, before tax, perhaps somewhat meaningful. 0.24% on $5,000 is only $12 a year before tax.
- The GSE Debt Market: An Overview at InvestingInBonds.com
- Agency/GSE New Issue Offerings at Fidelity Investments