CDs and Treasury bonds offer very high returns: here’s how to decide what’s best for you Do you want returns that last for years to come? Consider CDs or Treasuries.

When investing, there is often a trade-off between risk and return. Safer investments – such as bonds, money market funds and certificates of deposit (CDs) – tend to offer dismal returns, at least compared to stocks.

Thanks to the Federal Reserve’s series of rate hikes over the past year and a half, these safe investments are currently offering competitive rates. Since the spring of 2022, the Fed has raised the federal funds rate several times in an effort to cool inflation, bringing it from near zero to above 5%.

Now that prices are lower, the Fed is signaling rate cuts later this year. Investors looking to take advantage of stellar interest rates should consider locking in those rates early, and can do so with CDs or Treasury bills, bills, or notes (collectively known as Treasuries).

CDs versus Treasuries

While CDs and Treasuries are considered safe investments, as they provide returns that track the federal funds rate, the two have significant differences. Before investing, we recommend that you consider your investment horizon and the return you are looking for.

CDs and Treasuries explained

Typically, banks and credit unions offer traditional CDs and stock certificates. (Note: Brokered CDs work differently than traditional CDs and can be purchased from a broker.)

With traditional CDs, you lock up your money for a fixed period in exchange for a fixed interest rate. The lifespan of a CD can vary from a few weeks to years. CDs are more illiquid than Treasuries — you can access your cash before the investment reaches maturity, but it usually costs you.

If you tap into your cash before the CD’s term expires, you’ll pay an early withdrawal penalty, typically amounting to a few months’ interest. In general, we recommend choosing a CD that aligns with your investment goals: if you plan to use your money in a year, opt for a 1-year CD instead of a long-term one.

Although CDs are available in different durations, Treasury securities offer a wider range of maturities. They are a type of fixed income and bond investment. Think of the Treasury as a government IOU: You’re giving money to the federal government to finance its operations, and in return, you receive interest, either periodically or when the bond reaches maturity.

There are three types of Treasury securities:

  • Treasury bonds (Treasury bills): 4, 8, 13, 17, 26 and 52 weeks
  • Treasury Notes: 2, 3, 5, 7 or 10 years
  • Treasury Bonds: 20 or 30 years

Treasury bills differ slightly from Treasury bills and bonds. When you buy a Treasury bill, you buy it below face value (also known as par value), and once it reaches maturity, you receive the full face value. The difference between the face value and the price you pay is the interest.

With Treasury bills and bonds, however, you receive regular interest payments: Every six months until maturity, you receive a fixed interest rate.

You can purchase Treasury securities through TreasuryDirect or a brokerage account. However, Treasury bonds are more liquid than CDs.

If you want to leverage your money before your bond matures, you can sell it on a secondary market, which means you’ll have to give it to a bank or broker to sell it. If you purchase a Treasury security through TreasuryDirect you will have to hold it for at least 45 days before you can sell it.

Remember that when you sell bonds, they are susceptible to interest rate risk. This occurs when interest rates rise and cause the price of the bond to fall.

For example, if you buy a bond with a 4% yield and the interest rate rises to 5%, your bond will be less attractive to investors, so you may have to sell it for less than you initially purchased it.

How do fees accumulate?

CDs and Treasuries attract consumers with higher rates, at least compared to previous years. Currently, a 6-month and 1-year Treasury bond provides a yield of 5.20% and 4.80%, respectively. With a bond longer than 20 years, you can get a yield of 4.42%.

CD rates have also skyrocketed. Although they offer, on average, a lower yield than Treasuries.

As of January 2024, the national deposit rate for 12- and 60-month CDs was 1.86% and 1.41%, respectively.

“The 1-year Treasury bond yield is 4.80%. So why on earth? [would] someone holds their money in a 1.90% CD when the market rate is 300 basis points higher [on a T-bill],” says Preston Caldwell, the chief U.S. economist at Morningstar. “It seems like there is [sic] some people out there who haven’t been paying attention to short-term liquidity and fixed income holdings. It may be beneficial to ensure you earn the market rate at this time.”

Even though Treasuries boast higher rates than CDs, you can still get a generous annual percentage yield (APY) on a CD by shopping around. Typically, online banks offer higher interest rates than traditional banks. Some of the best CDs have APYs exceeding 5%.

Here are some institutions that offer stellar rates:

The best CDs by duration

Right now you can get a higher rate by opting for an investment with a shorter maturity. Typically, investors are rewarded for tying up their money for longer periods of time but, since the yield curve is currently inverted, you’ll get a better interest rate by choosing a shorter duration.

You may be tempted to choose a CD or Treasury with a shorter duration because it has a better rate, but you’ll want to consider reinvestment risk, or the possibility that rates will drop after your investment reaches maturity, forcing you to reinvest your your funds at a lower price. lower installment.

“I think it’s important to look at a variety of opportunities in fixed income. And not just CDs because these rates could drop very quickly and probably will over the next couple of years,” says David Rosenstrock, CFP and director of Wharton Wealth Planning. “Once rates go down, you run the risk of reinvestment.”

Rosenstrock advises people with longer investment horizons (such as those planning for retirement) to consider bonds with longer durations, which allow them to lock in a solid return for years to come.

If you’re investing for the long term (more than 10 years), a Treasury bond might be a good bet.

CD vs Treasury: Taxes and Risks

When choosing between a CD and a Treasury, you’ll also want to consider other factors, such as risk and taxation.

What about taxes?

While CDs have comparable returns to those offered on Treasuries, you may end up with more money in your pocket by investing in a Treasury rather than a CD.

The reason why? The interest you earn on your CDs is subject to both federal and state income taxes, while only federal income tax applies to interest income from Treasury bonds, not state or local taxes.

By calculating the tax burden on a CD versus a Treasury, you can get an idea of ​​what would be more profitable for you. For example, if you live in a state with a high income tax, it may be a better option to choose a lower-yielding Treasury versus a higher-yielding CD.

How safe are they?

CDs and Treasuries are both safe and relatively risk-free investments.

Because CDs are considered deposit accounts, they are covered by Federal Deposit Insurance Corp. (FDIC) insurance, up to $250,000 per depositor, per bank. You can check whether a bank is FDIC insured on the BankFind Suite website.

Treasury bonds are not bank products, but they are safe because they are backed by the U.S. government, which is considered unlikely to default.

The takeaway

When deciding whether to invest in a CD or a Treasury bond, you need to consider your risk tolerance, liquidity needs, and investment horizon.

Treasury bonds are a better choice for those who need more liquidity, have a longer investment horizon and prefer tax advantages.

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