How Investing in TFLO Could Earn You Passive Income

At Stash, we think about idle cash as the amount that is in excess of your everyday cash flow needs (disposable income) and the amount you might need immediately in an emergency. This type of cash usually sits idly in your savings account. 

Instead of keeping your disposable income in a savings account that earns very little, Stash recommends that you safely invest in an exchange-traded fund (ETF) that we call “U.S. Treasury Income,” more often known as iShares Treasury Floating Rate Bond ETF (ticker TFLO). As of February 10, 2023, U.S. Treasury Income pays a monthly distribution that equals 4.56% a year.

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TFLO frequently asked questions:

How does TFLO compare to rates paid by banks on savings accounts?  

As of January 17, 2023, the national average interest rate being paid on savings accounts is 0.33%. That means if you put $100 in a savings account, you would have $100.33 a year later (and possibly less if your bank charged you a monthly fee.) Many Americans have become accustomed to earning nothing on their hard-earned money. It has been commonplace for consumers to keep their cash at a bank and be paid little to nothing from their bank. But this hasn’t always been the case. 

During the 1990s, it was common for banks to pay 4-5% per year on savings accounts. In the 1980s, rates being paid on savings accounts were as high as 8%. During the Financial Crisis of 2007-2008, however,  the Federal Reserve (the “Fed”) cut interest rates to zero in order to stabilize the banking and financial system. The Fed uses interest rates to fuel or slow down the economy,similar to how you use  your gas pedal and brakes on your car. The Fed cuts rates to speed up the economy and raises rates to slow the economy and reign in spending. 

Last year, you may have heard people talking about inflation or you may have experienced it first hand when the prices of most everything went up. At the start of the pandemic, governments around the world, including the U.S., “printed” trillions of dollars in order to support the global economy. This decision led to excess spending by people and companies, which drove up demand (and thus prices) of many goods and services. In addition, pandemic-related shutdowns, coupled with Russia’s invasion of Ukraine, led to supply chain issues which further exacerbated the inflation issue. In order to address inflation and reign in spending, the Fed began the process of raising interest rates.

Typically the rates that you earn on your cash at a bank are determined by the interest rates set by the Fed.  However, despite higher interest rates, banks have not yet increased the amount they are paying to hold your cash. The good news is that there are investment products that offer high monthly distributions with limited investment risk. 

What is an Exchange-Traded Fund? 

An exchange-traded fund (ETF) is an investment that trades like a stock. However, ETFs are funds that hold a combination of stocks, bonds and/or other securities. Generally, by holding a bucket of different investments, ETFs balance risk and are safer than investing in one asset. Some ETFs track a market sector like energy or technology, while others mirror an index like the S&P 500. U.S. Treasury Income is an ETF that invests in U.S. Treasury obligations, which are considered the safest investments available as they are backed by the U.S. Government.  

Similar to a stock, an investor generally can earn money from an ETF in two ways: an ETF price increases or pays dividends. For example (purely for illustrative purposes),  if an investor named Gabby purchases an ETF that costs $50 and then next year, the purchase price increases to $60, Gabby has made $10, if she chooses to sell her position. If the ETF price drops, then Gabby would lose money. Gabby could also make money through an ETF’s dividends. These are part of the fund’s earnings and capital gains. Not all ETFs pay dividends, but many do. To see if an ETF pays dividends, Gabby would want to look at the potential dividend yield, which is the amount the fund pays out compared to the current market price of the share. At Stash, we recommend looking at the 30 Day SEC yield for all ETFs, as this is a standardized number that all ETFs publish. You can find this in the dividend yield section of all ETFs on Stash.

Now, here’s what’s different about U.S. Treasury Income. Unlike the example above, because of the underlying Treasurys that this ETF holds (more on this below), the price typically does not change that much. In fact, during all of 2022, the daily price change (adjusted for monthly distributions) stayed in a range of -0.10% and +0.15%. In full disclosure, Stash can’t guarantee this level of stability going forward, but based on the ETF’s underlying holdings, it would be reasonable to assume this pattern in the future. 

Instead of making money through price changes, U.S. Treasury Income pays a monthly distribution each month that is based on the most current interest rate. As of February 10, 2023, these monthly distributions add up to over 4.56% per year.  As long as the Fed keeps interest rates at these levels, U.S. Treasury Income should pay a similar monthly distribution. The current expectation is that the Fed will continue to raise rates in 2023, so this distribution may increase. If the Fed were to cut rates, then the distribution would decrease.

What are Treasurys? 

The U.S. Treasury, established in 1789, is most well-known for its job of raising money for the government’s expenses. The Treasury primarily raises this money through taxes and borrowing money from investors in the form of various Treasury obligations such as Treasury Bills, Notes, and Bonds (“Treasurys”). Treasurys are loans to the U.S. government for a set period of time, in exchange for a set rate of return or yield. When an investor chooses to purchase a Treasury with cash, they loan their money to the government. In exchange, the U.S. government promises to pay back the full loan amount (principal) plus interest over the life (maturity) of the loan. These Treasurys make regularly scheduled payments throughout the loan term. Treasurys are considered to be low-risk because they are backed by the U.S. government. In fact, unlike many other borrowers, the U.S. government can just raise taxes or print more money in order to pay its obligations. Many investors purchase Treasurys to diversify their investments, especially if they want to put their idle cash to work. As cash sits in a low to-no-interest bank account, inflation chips away at its value, so many investors put their money in a Treasury as a more productive alternative. 

What is the actual ETF?

At Stash, we know that the actual names of ETFs are sometimes long and confusing which is why we put shorter names that aim to simply describe what the ETF is. In the case of U.S. Treasury Income, the actual ETF is the iShares Treasury Floating Rate Bond ETF (ticker TFLO). Learn more about the ETF here. iShares, which is owned by Blackrock, is the largest provider of ETFs based on assets under management. Stash does not have any economic relationship with iShares.  

What does U.S. Treasury Income hold?

U.S. Treasury Income holds a combination of U.S. Treasurys that have a fluctuating interest rate. These Treasurys are called floating rate notes (“FRN”) and are short-term loans to the U.S. government that pay investors an income based on current market interest rates.

The U.S. government began issuing these FRNs in 2014. The interest rate on these FRNs resets weekly to the rate paid on the most current 3-month U.S. Treasury Bills. Since the interest rate resets every week, the value of the FRNs does not change. Typically the price of a debt security moves in the opposite direction of interest rates, so when interest rates rise, the price of the debt security goes down. That is not the case with these US Treasury FRNs. Since the TFLO ETF holds these Treasury FRNs, the price of the ETF tends to be very stable. As interest rates move higher, these FRNs pay out more, thus the ETF has more income to distribute and investors can benefit from the higher yields sooner.

As an added bonus, since TFLO holds U.S. Treasurys, virtually all of the income earned from distributions is state and local tax-exempt. 

How much should I invest in U.S. Treasury Income?

While Stash always recommends investing for the long term in a diversified portfolio, we know that many people may have short-term cash needs (for example, a large planned purchase within the next year) which may have some short-term risk associated with it. In these cases, we recommend investing this idle cash in U.S. Treasury Income as it offers a nice monthly distribution, is extremely safe relative to most investments, and offers daily liquidity or access while the stock market is open.  

What are the major risks? 

No investment comes without risks; however, Treasurys are considered to be extremely low-risk. This is because an investor in Treasurys is getting a guarantee from the U.S. government that the loan will be repaid. While there is talk in the news about the U.S. hitting its debt ceiling in the coming months, investors still consider U.S. Treasurys to be the safest investment. The talk over the debt ceiling is the result of the U.S. running a budget deficit (e.g., spending more than it is raising from taxes) for many years. While the government will need to figure out how to resolve this, which will result in a lot of saber rattling by both political parties, Stash does not believe that an actual default by the U.S. government is a realistic risk. Ultimately, the U.S. government has many options, including cutting spending, raising taxes, or just agreeing to raise the debt ceiling. 

Another risk to be aware of is that U.S. Treasury Income is not an investment in actual U.S. Treasurys, rather it is an investment in an ETF that owns U.S. Treasurys. While there is some small risk of tracking error or trading errors (for example, the ETF does not perform inline with its underlying holdings), Stash believes that TFLO is one of the safer ETF investments available. Therefore, TFLO isn’t technically a risk-free investment (no investment is 100% void of risk), but it is considered by many investors as close to it. 

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