When investing, there is often a balance between risk and reward. Safer investments, such as bonds, money market funds, and certificates of deposit (CDs), tend to offer paltry 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 spring 2022, the Federal Reserve has raised the federal funds rate several times in an effort to cool inflation, taking it from near zero to above 5%.
Now that prices are lower, the Federal Reserve is announcing rate cuts later this year. Investors who want to take advantage of stellar interest rates should consider locking in those rates early, and they can do so with CDs or Treasury bonds, bills, or notes (collectively known as Treasurys).
CDs versus Treasuries
While CDs and Treasuries are considered safe investments and offer returns that track the federal funds rate, the two have significant differences. Before investing, you’ll want to consider your investment horizon and the return you’re looking for.
CDs and treasury bonds
Banks and credit unions typically offer CDs and traditional stock certificates. (Note: Traded CDs work differently than traditional CDs and can be purchased at a brokerage.)
With traditional CDs, you tie 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 less liquid than Treasuries: You can access your cash before the investment reaches maturity, but it usually costs you.
If you use your cash before the CD’s term is up, you’ll pay an early withdrawal penalty, which is usually equal to a few months of interest. Typically, you’ll want to choose a CD that aligns with your investment goals; If you plan to use your money within a year, opt for a 1-year CD rather than a longer term.
While CDs have different maturities, Treasury bonds offer a broader range of maturities. They are a type of investment and fixed income bond. Think of a Treasury as a government note: You’re giving money to the federal government to fund its operations, and in return you receive interest, either periodically or when the bond reaches maturity.
There are three types of Treasury securities:
- treasure letters (treasure letters): 4, 8, 13, 17, 26 and 52 weeks
- Treasury Notes: 2, 3, 5, 7 or 10 years
- Treasury bond: 20 or 30 years
Treasury bills are slightly different from Treasury bonds and notes. When you buy a Treasury bill, you buy it below its 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 interest.
However, with Treasury notes and bonds, 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 securities are more liquid than CDs.
If you want to take advantage of your money before your bond matures, you can sell it on a secondary market, which means you will have to give it to a bank or broker to sell it. If you purchase a Treasury security through TreasuryDirect, you will need 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 is less attractive to investors, so you may have to sell it for less than you initially bought it.
How are fees accumulated?
CDs and Treasury securities attract consumers with higher rates, at least compared to previous years. Currently, a 6-month and 1-year Treasury bill offers a yield of 5.20% and 4.80%, respectively. With a longer 20-year bond, you can earn a 4.42% yield.
CD rates have also skyrocketed. Although they offer, on average, a lower yield than Treasury bonds.
As of January 2024, the national deposit rate for 12- and 60-month CDTs was 1.86% and 1.41%, respectively.
“The 1-year Treasury yield is 4.80%. “So why would anyone have their money sitting in a 1.90% certificate of deposit (CD) when the market rate is 300 basis points higher (on a T-bill),” says Preston Caldwell, chief economist at Morningstar for the United States. “It seems there are (sic) some people out there who have not been paying attention to their short-term cash and fixed income holdings. It might be beneficial to make sure you get the market rate right now.”
While Treasuries come with 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 that exceed 5%.
Here are some institutions that offer stellar rates:
The best CDs by duration of the semester
Right now, you can get a higher rate by opting for an investment with a shorter maturity. Investors are typically 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 if you choose a shorter duration.
It may be tempting 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 funds at a lower price. lower rate.
“I think it’s important to look at a variety of fixed income opportunities. And not just certificates of deposit, because those rates could go down pretty quickly and probably will over the next couple of years,” says David Rosenstrock, CFP and principal at Wharton Wealth Planning. “Once those rates go down, reinvestment risk arises.”
Rosenstrock recommends that people with longer investment horizons (such as those planning to retire) consider bonds with longer durations, allowing them to lock in solid returns for years to come.
If you’re investing for the long term (10+ years), a Treasury bond could be a good bet.
CDs vs. Treasuries: Taxes and Risk
When choosing between a CD and a Treasury, you’ll also want to consider other factors, such as risk and taxes.
What about taxes?
Although CDs have comparable returns to those offered on Treasury bonds, you may end up with more cash in your pocket if you invest in a Treasury instead of a CD.
The reason why? The interest you earn on your CDs is subject to federal and state income tax, while federal income tax only applies to interest income from Treasury bonds, not state or local taxes.
By calculating your tax burden on a CD versus a Treasury, you can get an idea of what would be more lucrative for you. For example, if you live in a state with high income taxes, it might be a better choice to choose a lower-yielding Treasury than a higher-yielding CD.
How safe are they?
CDs and Treasury bonds are safe and relatively risk-free investments.
Because CDs are considered deposit accounts, they are covered by Federal Deposit Insurance Corporation (FDIC) insurance, up to $250,000 per depositor, per bank. You can check if a bank is FDIC insured on the BankFind Suite website.
Treasury bonds are not banking products, but they are safe because they are backed by the U.S. government, which is considered unlikely to default.
Food to go
When deciding whether to invest in a CD or a Treasury, you should consider your risk tolerance, liquidity needs, and investment horizon.
Treasury bonds are a better option for those who need more liquidity, have a longer investment horizon, and prefer tax advantages.
