T Bills Explained with a Story of 2 Friends

Imagine that you have 2 friends, one of them comes up to you and says that he wants to start a bakery and needs 10,000 rupees for it. He says that he'll return you the money in 3 months with interest. This friend does not come from privilege and if he loses the 10,000 there is no way he will be able to return you this money.

On the other hand you have another friend who comes to you and says he wants to make a watch which people wear on their legs… Now this friend has a really rich father but he doesn't like his father that much and that's why he's coming and asking you for money, but since he has a rich father he gives you the assurance that even if his business fails he'll ask his dad for money and return you your 10,000.

The first friend has a stable business idea but a high risk of not returning the money and the second friend has a business idea which you don't understand but has the extreme safety and assurance that your money will be returned.

Now you tell me, to whom will you be comfortable lending money?

The guy with the rich dad right?

That's exactly what it means to lend money to the government. The government doesn't need money to build products but it needs money to build bridges, roads, schools and other infrastructure. Now even if you don't understand the economics of these projects it still makes sense for you to lend money to the government as it comes with sovereign guarantee. Meaning the Government of India will never run away with your money. This loan that you are giving to the government is completely risk free. The government will timely return you the money as it has promised.

One of the products that the government offers is the Treasury Bill. Now these bills are for 91 days, 182 days and 364 days. Lets focus on the 91 day bill for understanding purposes.

Your friend comes and says that give me 9,800 rupees and 91 days later I'll return you 10,000 rupees. Now he will not be paying any interest to you in these 91 days but you can see that you are earning a fixed return in these 91 days. That is 200 rupees.

So how much return are you earning?

200/9800 = 2.04%

So in these 3 months you are earning 2.04%. Please note that this is not the annualised return — this is just the return for the 3 months. If we simply multiply it by 4 to keep our calculations simple we see that we are getting an 8% annual return on this loan that we are giving to our friend.

The T bill works in a similar fashion — they come at a face value of 100, this basically means the government will return you 100 rupees after 91 days. The yield on T bills is usually somewhere around 5.5 to 6% per annum. Meaning you earn somewhere around 1.5% for 3 months. So usually you need to lend somewhere around 98.5 rupees to the government and 91 days later it returns you 100 rupees.

Now one thing that you might be thinking is that all of this for 1.5%? Well just for context, the money that you keep in your savings account earns 0.5% to 0.75% for 91 days which is half of what you get through T bills :)

The reason why the annualised interest is 5-6% lower than FDs and other debt instruments is because this is the lowest risk bond that is out there. Even your FDs are more risky than lending money to the Government of India :)

The difficult part about this is that you can't exit in between — your money gets locked for 91 days. Technically you can sell your T bills in between but it is very illiquid and it hampers your returns. I personally wouldn't suggest you to look at this as something you can easily sell in the secondary market like a stock. I would insist you look at this as your money being locked for 91 days and you getting that money back with interest.

Now why I like this product is because it is the safest way to build your investing habit.

The minimum investment in T bills is just 10,000 rupees. You can try your hand at it because it will make you realise the value of investing. So you will be buying this T bill for somewhere around 9,850 rupees and 91 days later the government will return you 10,000 rupees. You will just be earning 150 rupees. But there will be 2 major things that you will learn from this:

1. It will increase your confidence in investing.

   Once you make an investment in a security which ends up giving you a positive return 91 days later, this increases your confidence significantly. You can comfortably manage this as the money is locked only for 91 days — not a big deal — and you are starting with a very small amount that is just 10,000 rupees. Once you do this you can move to a T bill which is for 182 days, you can then move to a corporate bond, then move to gold, then move to mutual funds and eventually be more confident in investing in different products with different returns and different risk profiles.

2. You understand the value of investing.

   You will realise that money not touched is money not spent. Since you can't touch this money till 91 days you can't spend this money. You will realise how investing automatically eliminates any kind of unnecessary expenses that you make. If the money wasn't lent to the government you would've probably bought a new pair of headphones or a watch with this money.

Try it out if you want to.

I think one of the easiest ways to buy T bills is through Zerodha. This is in no way a paid promotion. I personally have been using Zerodha for the past 7 years and find it very convenient, hence attaching a link to a YouTube video which explains T bills in detail and how you can buy them through Zerodha.