Risks of Buying Stocks Compared to a Treasury Bill

Rate of return on your investment depends on its level of risk.

Rate of return on your investment depends on its level of risk.

There are several kinds of risks any investor should consider before committing money. Risks such as market, credit, interest rate and event risk apply to both stocks and bonds. Your investment fluctuates in value according to its degree of credit risk. Market and event risks, such as a bear market, geopolitical events, natural disasters and economic events are less severe for higher credit quality investments. Shorter maturities of Treasury bills are relatively risk-free.

Treasury Bills

The safest investments are very short-term interest-bearing investments guaranteed by the U.S. Government, such as U.S. Treasury bills. If you want to know that on a certain date in the future you will receive back the money you invested, T-bills are your best choice. The only exception occurs when economic conditions are so dire that T-bills trade at a negative interest rate. This is because the most sophisticated investors trust the U.S. Treasury to be a safe repository of their money. This rarely happens, but the investment return on very short-date T-bills is always the lowest because their credit quality is considered the highest. Their short term to maturity makes them relatively insensitive to fluctuations in interest rates. T-bills are discount investments, meaning that you buy the bill at less than its $1,000 face amount and receive the face amount when it matures. The difference between what you paid and $1,000 is your interest. T-bills are priced according to the interest rate the marketplace requires for that maturity bill on that particular date.

T-Bill Risks

The U.S. Treasury issues treasury bills in maturities ranging from a few days to 52 weeks. Interest rate risk affects all but the very shortest-term bills, so if you buy a year-bill, and sell it after a few months, you may not receive what you paid if interest rates rise during that time. For example, if the market rate for one-year Treasuries is 1 percent, you can buy a one-year Treasury bill for $990 and expect to receive $1,000 at maturity. If you want to sell it after holding it for 6 months, and interest rates have risen to 3 percent for that maturity, you will receive $985 before transaction fees. If interest rates had declined to .5 percent for the 6-month maturity, you would have received $997.50 upon sale, before transaction fees. If you hold the bill to maturity, you will still be repaid $1,000 no matter what happens in the market. Buying T-bills directly from the U.S. Treasury can be done without having to pay transaction fees, but your broker or bank may charge those fees.

Common and Preferred Stocks

Common and preferred stock can be relatively safe, and may provide a much higher investment return than Treasury bills. Common stock tends to fluctuate in price, according to whether the stock market is rising or falling. It also fluctuates based on the earnings expectations for its issuer. Common stocks that pay dividends and preferred stocks tend to fluctuate in price according to their dividend payouts relative to alternative interest rates available in corporate and Treasury bonds. When the general stock market declines, dividend-paying common stocks and preferred stocks tend to be less affected by the decline because of the value of their dividends. When prices in the general stock market decline, prices of Treasury bonds normally rise, making their interest rate returns lower. As interest rates decline, the value of stock that pays a strong dividend may actually rise because income investors take profits in bonds and buy the higher income available in dividend-paying common and preferred stocks.

Stock Risks

There is no face value payoff at maturity for stocks, as there is with T-bills. This means your investment principal is subject to market fluctuations. If the market is rising and your stock participates, it may prove a much better investment than a T-bill. However, stock prices are subject to price pressure from all investment risks, including interest rate risk, so you may lose a substantial portion of your money if you are forced to sell at a bad time in the market. The higher quality stocks tend to suffer less when the market drops, but they can still lose money. So if safety of principal is your top consideration, buy Treasury bills in maturities coinciding with the dates you may need your money.

 

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