Treasurys have been in the headlines and investors may be wondering whether these familiar sources of reliable yield and low risk make sense. To help answer that question, it may be worth comparing them to other familiar investment opportunities that also offer relatively attractive yields with historically lower volatility.
One of the most familiar of these is certificates of deposit (CDs) issued by banks. CDs and Treasurys have many similarities: Both can provide steady and predictable income while also preserving the value of your initial investment if you hold them until they mature. Both are available in a variety of maturities. Both also have been offering similar yields recently.
While both Treasury and CD yields are somewhat lower than they were a few years ago, they remain relatively attractive compared with the ultra-low yields that prevailed in the decade and a half following the global financial crisis.
How CDs and Treasurys differ
Given their similarities, it may seem that it doesn't make much difference which one you pick, but there are differences and understanding them may help you find the one that’s right for you.
Taxes: Treasurys can offer tax benefits that CDs can’t. Interest payments from CDs are taxed as income by state and federal governments, while interest income from Treasurys, though subject to federal income tax, is exempt from state and local income tax. If you want to reduce your tax bill as well as earn income and preserve capital, a Treasury may make more sense when held in a taxable account. This is especially true if you live in a high-tax state.
For example, suppose you are in the top tax bracket in California, which has a 13.3% top state tax rate, and are choosing between a 3-year CD that yields 3.9% and a 3-year Treasury that yields 3.51%. You might want to consider that the yield on the CD is only 3.38% after state taxes, while the Treasury enables you to keep the full 3.51% yield after state taxes.
Liquidity: Purchasing a CD or a Treasury involves giving up access to your money for a period of time in exchange for interest payments during that period. If you are certain you will not want to touch the money that you paid for your CD or Treasury before its maturity date, both a CD and a Treasury would likely work equally well for you. However, many people can’t be sure what their needs for liquidity may be, especially several years into the future. While it is possible to sell both brokered CDs and Treasurys prior to their maturity dates, the amount you receive from selling them may vary significantly. Like stock and bond markets, prices in the markets for existing CDs and Treasurys may rise or fall each day, depending on supply and demand from those individuals and institutional investors who may be buying and selling at any point in time. You may be able to sell a CD or Treasury before it matures for more than you paid, but could also receive less. Prices fluctuate based on market conditions, just like stocks and bonds.
If you need to sell a brokered CD prior to maturity, you may be able to sell it at the current market rate by requesting bids on your CD through your broker. If you decide to sell, you'll receive the bid price plus any accrued interest. There are no guarantees that you'll get what you originally paid and there may be a fee to sell the CD. Treasurys can also be bought and sold on a secondary market. However, it's a much more active and liquid market than the CD market, which means there are usually plenty of would-be buyers as well as would-be sellers. You could lose money if you need to sell a Treasury prior to maturity, but the Treasury market is a much more liquid market than the secondary CD market and therefore much easier to sell if needed. That means that if you think you may need the money prior to the time that your investment matures, you may prefer Treasurys over CDs.
Safety: A big part of the appeal of both CDs and Treasurys is the low risk that your principal won’t be returned to you at maturity. However, the way in which they provide security for your money is different for CDs and for Treasurys. CDs are issued by banks, they are generally insured by the federal government through FDIC insurance up to $250,000 per depositor, per FDIC-insured bank, per ownership category. You can purchase multiple CDs from different banks while still holding them in the same account type to protect more than $250,000. For example, if you own 2 CDs in your brokerage account, $250,000 from one bank and $250,000 from a second bank, and you have no other deposits at those banks, you're covered for $500,000.
Treasurys, on the other hand, are backed by the full faith and credit of the US government with no limit. That means the government has the power to raise taxes or take other measures to ensure there’s money available to pay you back at maturity. Because of this, Treasurys may be a better choice if you want to put a large amount of money into low-risk investments.
Selection: Fidelity's clients can purchase brokered CDs issued by a wide variety of banks, whose rates and payment intervals differ. Treasury bills pay when they mature and Treasury notes and bonds pay interest semi-annually. CDs may pay interest semi-annually, monthly, or quarterly, depending on the issuer. On the other hand, Treasurys provide more options for longer-dated securities than CDs. Generally, CDs are not offered beyond 10 years while the Treasury market regularly offers 20- and 30-year bonds. Finally, the Treasury market also offers Treasury Inflation Protected Securities (TIPS), which provide inflation protection, while CDs do not.
How much is too much?
Once you’ve decided between CDs or Treasurys, you can enjoy the peace of mind that comes from reliable income and the potential for capital preservation. What you still face though is the possibility that inflation will eat away at the value of the interest payments and the initial investment in CDs and Treasurys alike. That’s because these low-risk investments lack the higher-growth potential of stocks and some riskier bonds. That means you’ll likely still need some stocks and other investments to go along with your allocation to low-risk investments. Fidelity can help you determine how much to put into each type of asset so that you are diversified across different asset classes.
You can research or buy CDs and Treasurys quickly and easily with Fidelity. Our specialists in fixed income are available to answer questions and help you find bonds that may be a good fit for your investment strategy.