Since the financial crisis in 2008, CD rates have been consistently higher than equivalent term Treasury notes (notes have a maturity between one and 10 years). As a result, in most cases, an investor could get a better rate if they looked to CDs. As the chart below shows, this calculus has changed a bit over the last six months as the rates on Treasuries have shot up with the accelerating economy.
So, if you have a chunk of money to invest in a risk-free asset, which will be it be: CDs or Treasury notes?
A current comparison of Treasuries versus the best CD rates from DepositAccounts.com shows the following:
Comparison of Treasury Note Yields to the Best CD Rates
|Term||Treasury Yield||Best CD Rate (APY)|
As the chart above shows, Treasury note rates are close to CD rates now. And this chart includes the best rates from across the country. Treasury rates are above the average CD rate for the most common terms.
Because income from Treasury notes is state and local tax-exempt, their return against CDs is even more favorable in high-income tax states. In a state with a flat 5.1% income tax rate like Massachusetts, the return comparison looks like the following:
|Term||Tax Equivalent Yield at 5.1%|
State Income Tax Rate
|Best CD Rate (APY)|
For someone living in California at the top tax bracket of 13% (people earning over $1,000,000/year), the analysis looks like:
|Term||Tax Equivalent Yield at 13%|
State Income Tax Rate
|Best CD Rate (APY)|
From a return standpoint, Treasury notes and CDs are virtually indistinguishable right now. But there are reasons to consider one over the other.
Investors can sell their Treasury notes at any time on a very active secondary market in increments of $100. This gives an investor the flexibility of determining when to sell their notes and how much of their portfolio to liquidate.
Depositors who sell their CD before the end of the term (“breaking the CD”) must pay a penalty, which can often eat up a significant chunk of the return. CD breakage penalties range from three to 12 months of interest, often wiping out a significant portion of the deposit’s return. In many cases, you must sell the entire CD. Partial early withdrawals of principal are often not allowed.
Both Treasury notes and CDs are extremely safe investments. Treasuries are backed by the full faith and credit of the United States. There has never been a missed payment, although it’s been close in the past few years when the government deadlocked on the authorization to raise the debt limit. Investors can hold as much in Treasuries as they would like, meaning there is no limit to the size of the guarantee the government will provide an investor.
CDs are backed by the FDIC up to $250,000 per institution, per individual, for each account ownership category. To receive over $250,000 in protection within one ownership category, an individual must open a CD at another institution or have a spouse open the CD at the same institution. To deposit large sums of CD money and still be covered by the FDIC, an individual has to open multiple accounts at several different institutions. FDIC-insured depositors have never lost money since the establishment of the FDIC during the Great Depression in 1933.
When a bank is closed or fails, the FDIC moves in quickly to ensure that all FDIC-insured deposits are kept whole. During the financial crisis, failed banks were often shut down on a Friday, and the money was available to deposit by the following Monday.
Although depositors who remain below the FDIC limits are made whole in the case of a bank failure, the FDIC or a bank that assumes the failed deposits is not required to honor the original CD rates of the failed bank.
CDs at federally-insured credit unions are backed by the NCUA with coverage limits that mirror the FDIC’s.
If you plan to hold Treasury notes and a CD to maturity, then both instruments will pay you the listed rates and you will receive your principal back. But, if you need to exit early from an investment, there are differences. Treasury prices fluctuate on a day-to-day basis based on the economy, creating what is called interest-rate risk. In a rising rate environment, the market value of a Treasury will decline as interest rates climb. Investors would rather purchase a new treasury at the higher rate, and to get them to purchase a lower yielding Treasury, the market value must be marked down to equalize the return. An investor who needs to liquidate their position might be forced to sell with a loss of principal. If interest rates jump, depending on the duration of the note, an investor could lose a significant amount of principal.
If interest rates rise after the opening of a direct CD, the value of the CD will not change like with Treasuries. That’s because CDs are not liquid and are not meant to be bought and sold. If an investor decides they want to take their money out before the end of the term and reinvest it in a higher yielding CD, they’ll need to “break the CD.” This often results in a penalty to the interest earned and rarely in the principal invested. These penalties are explained in the CD terms and conditions. DepositAccounts provides a calculator to help investors calculate these breakage fees.
You cannot walk into a bank branch and purchase a Treasury note. Treasuries can be purchased online from the Treasury website at Treasurydirect.gov or from a brokerage. There are no fees to purchase notes from the website. Brokerage charges are generally $0 for new issues and very low fees ($1 per bond) for secondary market transactions. The fee can be higher to buy and sell via a phone or branch transaction. Using Treasurydirect.gov or an online brokerage will require the user to set up an account and send the funds via an electronic bank transfer.
CDs can be opened and funded by walking into most bank branches or using online banking. There is no fee to open a CD. The best CD rates are generally offered by online banks, and require the depositor to open an account online and use an electronic bank transfer to send the funds, much like a Treasury transaction.
Both CDs and Treasury notes can utilize many of same investing strategies to generate cash and minimize interest rate risk. One of the most common of these is laddering. While laddering can be done with both Treasuries and CDs, there are some key differences.
Investors ladder CDs to make their portfolio more liquid and to also minimize interest-rate risk. DepositAccounts has a good article on CD laddering here.
Treasuries are already liquid so there is no need to ladder them for this reason. Instead, investors ladder Treasuries to smooth out interest-rate risk and to provide a predictable flow of income.
Like CD laddering, Treasury laddering involves purchasing notes in a variety of terms. For example, an investor could purchase 1-, 2-, 3- and 5-year treasury notes. As the 1-year note matures, the money can then be reinvested into a new 5-year note. There are some nuances to when a Treasury payment is made and when to reinvest, but between new issues and purchasing notes on the secondary market, an investor can generally maintain their ladder. If interest rates rise during this period, the money can be reinvested at this new higher rate. Laddering ensures that money is always coming due and being reinvested at the prevailing market rate, reducing interest rate risk.
Which way to go?
So, should you put your money into a CD or a similar term Treasury note? Until recently, the answer for those interested in maximizing income was to go with the higher yielding CD. But the recent spike in interest rates provides investors with another alternative to earn some yield on a no-risk investment. Which to choose depends on personal circumstances and preferences. For savers long suffering from low rates, a second alternative is welcoming news.