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Have You Checked Your Taxable Equivalent Yield Lately?

Bozo
  |     |   1,375 posts since 2011

Unless you are a bond aficionado, the answer is probably "no". For residents of states with high personal income taxes, check out the rate on the 5-year Treasury. Last I checked, it was 2.54%. In order to obtain that yield on a fully-taxable retail CD, a CA resident, at a marginal rate of 9.3%, would need a 5-year CD yielding (drumbeat) 2.8%.

Treasuries are exempt from state income taxes.

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jib2424
  |     |   34 posts since 2014
Putting aside any considerations of rates, what advantages do treasuries have over CDs?
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Bozo
  |     |   1,375 posts since 2011
Jib2424, a Treasury "might" have greater value than a comparable CD if cashed-in early. Depends on the secondary market (for the Treasury) and the EWP for the CD.

Example: Assume Joe buys a five-year $100,000 Treasury at 2.54% and a five-year $100,000 CD at 2.8%. Two years from now, Joe wants out. Rates have risen since Joe bought. The secondary market is willing to pay Joe only 95 cents on the dollar for his Treasury (a loss of 5%). His CD will charge him 365 days of interest as an EWP, a loss of $2800. Joe is better off with the CD.

Example#2: Same as above, but rates have barely budged. Joe can obtain 99 cents on the dollar for his Treasury (a loss of $1000), The 365 day EWP on his CD still applies. Joe's Treasury is the better deal.
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jib2424
  |     |   34 posts since 2014
treasuries are direct obligations of the US government. Also, treasury direct makes purchases and withdrawals much easier and simpler than buying and redeeming CDs. At what interest rate do five year treasuries become a better deal than five year CDs?  Also, there is no $250,000 limit on insurance.  Thanks, Bozo.
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Bozo
  |     |   1,375 posts since 2011
"At what interest rate do five year treasuries become a better deal than five year CDs?" Jib2424, it depends on your particular taxable equivalent yield. A person in a low- or no-personal-state-income-tax state will have a different break-even point.

An easy example would be FL. Since FL has no state income tax, the Treasury yield is, by definition, the taxable equivalent yield.
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Kaight
  |     |   1,192 posts since 2011
Bozo, it has been many years since I did govvies. And I'm well aware how easy it is today to buy Treasury notes, bills, and bonds on the net. I commend your having pointed out the benefits for persons living in high tax states.

Back when I did govvies, though, I did not limit myself to Treasury instruments. I bought all sorts of Federal paper, on all of which the interest was state tax exempt. That was many years ago and I was dealing with bond brokers. I do not know today whether or not other govvies, other than Treasury stuff, can be bought on the net.

I can tell you all that govvie paper is dollar good (I never lost a farthing), and oftentimes you can obtain better yields than what's available on gilt-edge Treasury paper, while retaining the exemption from state tax. I used to buy Federal this and Federal that, Federal agency bonds,  and even bought some TVA bonds back in the day. All the interest was state tax exempt.

There is also opportunity, for those interested in agency paper generally and in the TVA, to make money with callable bonds.  You have to study the overall patterns of the agency's issuance, the agency's call history, and of course you have to have a clue about the direction interest rates are headed.  Profits on callable bonds are quite sweet.  And all along, even if you get it wrong, the bonds are dollar good and pay state tax free interest.  So the downside risks are pretty well contained.

ETA

I need to mention that while interest on many Federal agency and GSE bonds is exempt from state tax, there are exceptions.  So look before you leap.  Check before buying to be certain interest on the bonds you have selected is, indeed, state tax exempt. 

.
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