The term "mutual fund" encompasses a wide spectrum of financial assets. While some mutual funds are quite safe, some carry a substantial amount of risk. Treasury bills, on the other hand, are essentially the safest investment and carry, for all intents and purposes, zero risk.
Treasury bills, also known as T-bills, are short-term borrowing instruments that are issued by the U.S. Department of Treasury. In other words, they represent the borrowing obligation of the federal government. A Treasury bill has an expiration date ranging from one day to half a year. On the expiration date you, or your broker on your behalf, will return the Treasury bill and get your money back from the U.S. Treasury. Should you need access to cash, you can sell the bill to other investors before the expiration date. The risk of the Treasury failing to honor its payment obligation is essentially zero, since the federal government can always print money to pay its debt. Treasury bills therefore carry no repayment risk and are safer than mutual funds.
A mutual fund is a pool of money, managed by professional investors on behalf of other people. They are ideal for investors who do not have the time or expertise to follow individual stocks or bonds. To compensate the professionals managing your money, you pay a flat percentage fee every year. Some funds also charge a fee every time you withdraw money, to discourage frequent withdrawals. Since mutual funds hold a large number of financial assets, even as a small participant in the fund, you get the benefit of diversification. While it may not be practical to buy dozens of stocks with your $2,000, such a contribution to a mutual fund results in a diversified portfolio that won't suffer greatly from the failure of any one company.
Mutual Fund Types
Mutual funds vary greatly in terms of risk. What the mutual fund will purchase with the money you entrust it is detailed in the official document called the prospectus. Except a few very risky financial instruments, which mutual funds cannot purchase by law, a mutual fund can hold practically any financial asset, as long as such assets are spelled out in its prospectus. A fund investing in bonds issued by medium-quality corporations or stocks of small firms can be relatively risky. On the other hand, a fund investing in bonds issued only by the most reliable companies, such as the Microsofts and Wal-Marts of the world, is quite safe. You should therefore read the prospectus of the mutual fund carefully before investing in it.
Risk vs. Return
In finance, risk and return go hand in hand. Since Treasury bills are essentially the safest asset you can buy, they also tend to provide the lowest return. In general, the return from a Treasury bill is only marginally above inflation. As such, a Treasury bill is more suitable for investors who desire to preserve what they have, as opposed to growing their money. A mutual fund is more likely to grow your investment at a rate far exceeding inflation. However, mutual funds can also lose value. Instead of picking either mutual funds or Treasury bills with all your investable assets, a mix of both may be a good choice and could help you find the ideal compromise between risk and return.
Hunkar Ozyasar is the former high-yield bond strategist for Deutsche Bank. He has been quoted in publications including "Financial Times" and the "Wall Street Journal." His book, "When Time Management Fails," is published in 12 countries while Ozyasar’s finance articles are featured on Nikkei, Japan’s premier financial news service. He holds a Master of Business Administration from Kellogg Graduate School.