I’ve been getting a flurry of questions about comparing Treasury Bills to bank accounts. Here is a step-by-step walkthrough to make it from the weekly auction results to a bank’s quoted APY interest rate.
1. From the recent auction results page, grab the investment rate (not discount rate). This is APR. It is based on a 365-day year and reflects the actual annualized rate to maturity. Here’s the most recent snapshot:
Let’s take the 28-day T-Bill, which has an APR of 5.247%, or 0.05247.
(If you want to learn more about how the other terms and the relationship between “Discount rate” and “Investment rate”, please see this post on T-Bill terms.)
2. Convert it to APY. APY, as opposed to APR, takes into account the effect of compounding interest. It’s also a higher number, which is why most banks just tell you the APY. An approximate way to convert it to APY is using this formula:
APY = (1 + (APR/PeriodsInAYear) )^(PeriodsInAYear) – 1
For our case, the APR is 0.05247 and PeriodsInAYear= 365/28. Solving for APY, you get 0.05376, or 5.376% APY.
This is only a approximation because you can’t actually reinvest all of the money continuously. For example, you might get back $1,000 from your first T-Bill, but can only reinvest $995 of it in the next T-Bill. The rest must sit in a savings account at best. For 28-day T-Bills, you can get a more accurate number using my 28-Day Treasury Bill APY Calculator.
Assuming a 4.89% APR/5% APY savings account, you’d get 5.367% APY, a bit less. If you don’t pay state or local income taxes, you can stop here. As you can see, it’s very competitive with online savings accounts.
3. Find Your Tax-Equivalent Rate. Treasury Bills are exempt from state and local taxes. Thus if you are subject to such atrocities , then your T-Bill rate is actually better than that of a fully-taxable bank account. This is one use for my tax-equivalent yield calculator. You’ll need to know your tax rates and whether you itemize taxes.
Let’s use the 5.367% number from Step 2 and my own tax situation. For 2007, I’ll probably be in the 28% bracket federally, 9% for state, and will itemize. For this specific T-Bill, my final number that I should use to compare to banks is 5.898% APY. Your number will probably vary.
Yes, there are a lot of variables to get the conversion just right. Sorry!
If you are interested in investing in Treasury Bills, please also see my visual guide to building a T-Bill ladder to maximize your returns and also liquidity.