Question

The average return on large cap stocks has outpaced that of US Treasury bills by about 7% per year since 1926. Why, then, does anyone investment in Treasury Bills?

Answer 1

U.S Treasury bills are money market instruments which are backed by the U.S government and thus they are risk free. These are issued for a period up to one year and carry lower rate of return. These treasury bills are sold at a price which is lower than its face value.

One of the major reason why someone would prefer investing in Treasury bills rather than large cap stocks is risk. Large cap stocks can provide better returns than a treasury bill but the investor also has to take the risk on such stocks. The stock markets are volatile, the changes in stock prices can happen upwards as well as downwards. For a risk averse investor stocks might not be an attractive investment proposal. He will prefer investing in treasury bills as the risk of default is negligible. He may not earn a good return as compared to large cap stocks but he would definitely avoid the risk of his investment getting affected.

Suppose an investor invests a significant part of his savings in large cap stocks in the hope of getting good returns. Due to various factors the company goes out of business then the investor risks losing a huge sum of money. Whereas had he invested in treasury bills his money would have been safe despite of unfavorable market conditions.

Therefore any investor who seeks to safeguard his investment and at the same time earn returns will choose treasury bills over large cap stocks.