T-Notes

T-Notes (also known as Treasury Notes) are a type of debt security issued by the U.S. Department of the Treasury to finance government spending. Think of them as a loan you make to the U.S. government. In return for your loan, the government promises to pay you a fixed interest rate every six months until the note matures, at which point it repays your original loan amount, known as the par value. T-Notes are issued with maturity periods of 2, 3, 5, 7, and 10 years, placing them in the middle of the government debt spectrum, between short-term T-Bills and long-term T-Bonds. Because they are backed by the “full faith and credit” of the U.S. government, they are considered one of the safest investments on the planet. This safety makes them a cornerstone for conservative investors and a benchmark for the entire financial world.

Investing in a T-Note is straightforward. They are typically sold via auctions, but most investors buy them through a broker or the TreasuryDirect website. Once you own a T-Note, you receive interest payments, called coupon payments, twice a year. For example, if you buy a $1,000, 10-year T-Note with a 3% coupon rate, you will receive $30 in interest per year. This is paid out in two $15 installments every six months for the entire 10-year term. At the end of the 10 years, when the note “matures,” the government pays you back your original $1,000 principal. While you can hold a T-Note until it matures, they are also highly liquid, meaning they can be easily bought and sold on the secondary market. On this market, their price fluctuates. If new T-Notes are being issued with higher interest rates, the price of your older, lower-rate note will fall, and vice-versa. This inverse relationship between price and prevailing interest rates is a key concept for all bond investors. The effective rate of return based on the current market price is known as its yield.

For a value investor, whose primary goal is to buy assets for less than their intrinsic worth, T-Notes play a different but vital role. You don't “value” a T-Note in the same way you value a business like Coca-Cola. Instead, its value lies in its function as a tool for risk management, capital preservation, and discipline. The great Benjamin Graham, the father of value investing, advocated for a portfolio balanced between stocks and high-quality bonds for the “defensive investor.” T-Notes fit this role perfectly.

• Capital Preservation: The number one job of a T-Note in a portfolio is to keep your capital safe. After a successful run in the stock market, moving profits into T-Notes is a prudent way to protect those gains from market volatility.
• Portfolio Ballast: T-Notes often act as a safe-haven asset. During stock market panics, investors rush to the safety of U.S. government debt, often causing T-Note prices to rise as stock prices fall. This can provide a stabilizing cushion for your overall portfolio.
• The Ultimate Benchmark: The yield on the 10-year T-Note is globally recognized as the risk-free rate. This is the theoretical return you can earn on an investment with zero risk. Value investors use this rate as a baseline to determine if the potential return from a riskier asset, like a stock, is high enough to be worth the danger. If a stock is only expected to return slightly more than a 10-year T-Note, it's probably not a good bet.

While incredibly safe from default, T-Notes are not entirely without risk.

• Interest Rate Risk: This is the big one. If you need to sell your T-Note before it matures and interest rates have gone up, you will have to sell it at a discount. The longer the note's maturity, the more sensitive its price is to interest rate changes.
• Inflation Risk: The fixed coupon payments can be a double-edged sword. If inflation rises sharply, the fixed interest you receive may not be enough to maintain your purchasing power. Your real return (your return after inflation) could become negative.
• Opportunity Cost: By choosing the safety of a T-Note, you are inherently giving up the potential for higher returns from equities. It is the fundamental trade-off between safety and growth that every investor must navigate as part of their asset allocation strategy.

• Issuer: U.S. Department of the Treasury.
• Maturities: 2, 3, 5, 7, and 10 years.
• Interest: Pays a fixed coupon payment every six months.
• Risk Level: Extremely low credit risk. The primary risks are related to changes in interest rates and inflation.
• Liquidity: Very high; easily traded on the secondary market.
• Taxation: For U.S. investors, the interest income is subject to federal income tax but is exempt from all state and local income taxes.