Nearly everyone holds some cash in their portfolio, either to invest later, pay upcoming expenses, or provide a counterbalance to riskier investments. Often, we aren’t exactly sure how and when we will spend or invest our cash, and thus want easy access regardless of market conditions. The basic choice is a 1-month Treasury bill, but really any Treasury instrument will do as they can be sold quickly if we need funds immediately.
Storing cash in Treasuries helps avoid credit or liquidity risk but may involve duration risk – if rates unexpectedly rise more than expected, then you could get back less than you invested. The main goal for reserves is liquidity, but there is a secondary goal of generating income to help mitigate the inflationary drag of holding cash.
Exhibit 1 compares the historical average one-year holding period return for each major Treasury maturity (1-month, 3-month, 6-month, 1-year, 2-year, 5-year, 10-year and 30-year) versus its largest-ever one-year decline.
Exhibit 1: Average 1-Year Return vs. Largest 1-Year Decline (various Treasury maturities)
Source: FTSE Treasury Benchmark Index, Janus Henderson, January 1980 to April 2022. Note: Constant maturity total return series, rebalanced monthly, excludes transaction costs. Past performance is no guarantee of future results.
Clearly, historical returns are far above current rates. Nevertheless, the graph shows that despite various periods of rising and falling rates over the last 42 years, holding 1-year or 2-year Treasuries rather than shorter bills has generally enhanced returns while introducing minimal drawdown risk. Interest rate sensitivity for these maturities is low as existing hike expectations get priced in. For example, the 2-year note today already reflects the rising rate profile implied by markets and the median path of the Federal Reserve (Fed) dot plot, which records each Fed official’s projection for the federal funds rate.