Bonds vs Treasury Bills: Key Differences Explained

Bonds and Treasury bills (T-bills) are both fixed-income securities that provide investors with predictable returns, but they differ in terms of duration, risk, return, and other characteristics. Understanding these differences is essential for investors deciding between the two based on their financial goals, risk tolerance, and investment horizon.

Let’s compare Bonds and Treasury Bills to help you understand their respective features, advantages, and disadvantages.

1. Nature of the Investment

• Bonds: A bond is a debt instrument where an investor loans money to a government, corporation, or other entity in exchange for regular interest payments (coupon payments) and the return of the principal at maturity. Bonds have a fixed term (ranging from a few years to decades) and typically provide regular interest payments.

• Treasury Bills (T-Bills): T-Bills are short-term debt instruments issued by the government, usually with maturities ranging from a few days to one year. T-Bills do not pay regular interest like bonds. Instead, they are sold at a discount to their face value, and the investor receives the full face value at maturity. The return on a T-Bill is the difference between the purchase price and the face value.

2. Maturity Period

• Bonds: Bonds come with a longer maturity period, usually ranging from 1 year to 30 years. The term of the bond depends on the issuing entity and the specific type of bond. Long-term bonds typically offer higher yields to compensate for the risk of holding the bond over a longer duration.

• T-Bills: T-Bills are short-term securities, with maturities of up to one year. They are available in various maturity periods, such as 91-day, 182-day, and 364-day T-Bills. These instruments are designed to meet short-term funding needs for the government.

3. Interest Payments

• Bonds: Bonds typically pay regular interest (referred to as coupon payments) to the bondholder, usually every six months or annually, depending on the bond’s structure. This interest payment provides a steady stream of income to bondholders.

• T-Bills: T-Bills do not pay regular interest. Instead, they are sold at a discount to their face value, and the investor receives the full face value at maturity. The difference between the purchase price and the maturity value constitutes the return for the investor. This return is earned at maturity rather than through periodic interest payments.

4. Risk

• Bonds: Bonds are subject to various risks:

  • Credit Risk: If the bond issuer faces financial difficulties or defaults, the investor may not receive interest payments or the principal at maturity. Bonds issued by corporations are more exposed to credit risk compared to government bonds.

  • Interest Rate Risk: If interest rates rise, the price of existing bonds falls, which can impact the bondholder if they sell the bond before maturity.

  • Inflation Risk: The value of fixed coupon payments may be eroded by inflation over the life of the bond.

• T-Bills: T-Bills are considered to be virtually risk-free in terms of credit risk because they are backed by the full faith and credit of the government. However, T-Bills still face interest rate risk. If interest rates rise during the term of the T-Bill, newly issued T-Bills will offer higher yields, potentially making existing T-Bills less attractive in the secondary market.

5. Return Potential

• Bonds: Bonds offer higher returns than T-Bills, especially if the bond is longer-term or issued by a corporation with a lower credit rating. The yield on bonds is generally higher to compensate for the longer duration, credit risk, and potential market fluctuations.

• T-Bills: T-Bills generally offer lower returns than bonds because of their short-term nature and minimal risk. Since they are considered almost risk-free (due to government backing), they tend to provide lower yields than bonds. The return on a T-Bill is calculated as the difference between its purchase price and its face value.

6. Liquidity

• Bonds: Bonds are generally less liquid than T-Bills, especially if they are issued by corporations with lower credit ratings or if they have long maturities. While government bonds (like U.S. Treasury bonds) are more liquid and can be traded easily, corporate bonds and bonds with lower credit ratings may be more difficult to sell at market value, particularly during times of economic uncertainty.

• T-Bills: T-Bills are considered highly liquid because they have short maturity periods and are backed by the government. They can be easily sold in the secondary market if needed. Since T-Bills are issued with relatively small denominations (often starting from ₹25,000 or its equivalent), they are accessible to retail investors and can be quickly converted to cash.

7. Tax Treatment

• Bonds: Interest income from bonds is generally taxable. The taxation can vary depending on the type of bond and the country. For example, municipal bonds in some regions (e.g., U.S. municipal bonds) may offer tax-free interest at the state or local level. Additionally, capital gains from selling bonds before maturity are subject to capital gains tax.

• T-Bills: The interest income from T-Bills is subject to tax. However, in some countries (like the U.S.), interest earned on T-Bills may be exempt from state and local taxes but still subject to federal taxes. As T-Bills are sold at a discount, the return is considered as the interest income for tax purposes.

8. Issuers

• Bonds: Bonds can be issued by governments (e.g., government bonds, sovereign bonds, municipal bonds) or corporations (corporate bonds). The creditworthiness of the issuer plays a significant role in determining the risk and return of a bond. Government bonds tend to be safer, while corporate bonds can offer higher yields but come with higher risk.

• T-Bills: T-Bills are issued exclusively by the government (e.g., U.S. Treasury, Indian Government). As a result, they are considered to be low-risk and are backed by the government’s credit.

9. Minimum Investment

• Bonds: The minimum investment required to buy bonds depends on the bond type and the issuer. For government bonds, the minimum investment can range from ₹1,000 to ₹10,000 or more. Corporate bonds may require a higher investment amount, especially for retail investors.

• T-Bills: The minimum investment for T-Bills is generally lower compared to bonds. In many countries, the minimum denomination is usually around ₹25,000 or its equivalent. This makes T-Bills more accessible to small investors.

10. Use in Investment Portfolio

• Bonds: Bonds are used to generate income through regular coupon payments and to diversify an investment portfolio, providing exposure to fixed income. They are often used by investors looking for predictable returns and stability, especially during periods of low stock market performance.

• T-Bills: T-Bills are mainly used as a short-term, low-risk investment or a cash-equivalent. They are ideal for investors looking to park their funds for a short duration while earning a small return. T-Bills are often used as a temporary place to store capital before deciding on a long-term investment strategy.

Summary: Bonds vs Treasury Bills

Aspect	Bonds	Treasury Bills (T-Bills)
Nature	Debt instruments with interest payments	Short-term debt instruments with no interest
Maturity Period	Long-term (1 year to 30 years)	Short-term (up to 1 year)
Interest Payments	Regular coupon payments	No interest; sold at a discount
Risk	Higher risk (credit risk, interest rate risk, etc.)	Low risk (backed by government)
Return Potential	Higher returns (depending on issuer and maturity)	Lower returns (due to short-term nature)
Liquidity	Less liquid (depending on issuer)	Highly liquid (can be sold in secondary market)
Tax Treatment	Taxable interest and capital gains	Taxable, but exempt from state taxes in some countries
Issuers	Government, municipalities, corporations	Government only
Minimum Investment	Varies (usually ₹1,000 or more)	Lower minimum (₹25,000 or equivalent)
Use in Portfolio	Income generation, long-term investment	Safe, short-term parking of funds

Conclusion

• Bonds are more suitable for investors looking for higher returns over a longer time horizon, and are willing to take on some credit risk and interest rate risk.

• Treasury Bills (T-Bills) are ideal for conservative investors or those with a short-term investment horizon. They offer low risk, high liquidity, and short-term returns, making them a good choice for parking cash temporarily while earning a modest return.

The choice between bonds and Treasury bills depends on your investment goals, risk appetite, and time horizon. Both instruments serve different needs, and understanding their key differences can help you make the best decision for your financial situation.