Certificates of Deposit (CDs) are a type of bank deposit account that pays a fixed rate of interest over a specified period. The term period can be anywhere from a month to several years. Surging interest rates have renewed interest in CDs, especially among conservative investors and those looking for an alternative to low-yielding savings accounts.
CDs are currently yielding as much as 5% for 6-month and 1-year maturities at places such as Marcus by Goldman Sachs. 3-5 year CDs can yield as much as 4.5%. While those perceived safe yields have enticed many savers, I think there are better ways to save.
Why don’t I like CDs?
- Liquidity: CDs carry penalties when you withdraw your money before maturity. Short-term CDs often require you to surrender 3 months of interest while longer-term CDs require as much as six months of interest.
- Credit Risk: Any amount invested over the FDIC limit of $250K is uninsured, which makes you an unsecured creditor of the bank or credit union. With all the bank failures in 2023, we’ve seen banks are not always safe.
- Taxes: Unless held in a retirement account, interest on CDs is taxable at both the federal and state/local level.
- Call Risk: Some CDs have call provisions, meaning the bank can call the CD and stop paying you interest by giving you your money back early. This usually occurs when interest rates fall, which is especially problematic since your reinvestment options will be at less attractive lower yields.
Treasury Bills: A Better Alternative
US Government Bonds are generally considered the safest asset in the world and the yield on treasury securities is called the risk-free rate in finance. US Government bonds, aka treasury securities, are among the most liquid and highly traded securities in the world. Here’s the yield on a variety of US Treasuries:
CDs generally yield less than Treasury securities, especially on shorter-term maturities. The difference is even more pronounced when you compare the average yield on CDs instead of just the highest yield available:
Let’s analyze Treasuries on the same criteria we used for CDs:
- Liquidity: Treasuries are one of the most liquid assets in the world and can be easily bought/sold. You can sell treasury securities at any time without penalty.
- Credit Risk: Debt ceiling shenanigans aside, Treasuries are considered the closest thing to a risk-free investment that you can get.
- Taxes: Interest on treasury securities is exempt from state and local taxes (although still subject to federal taxes).
- Call Risk: Treasuries are not callable.
In my opinion, Treasury Bonds are a safer and better option for the vast majority of savers. The best way for most savers to purchase Treasuries is directly through the US government at TreasuryDirect.gov. That allows you to purchase government bonds without any fees. Note that to sell a Treasury you’ll have to transfer the security to a brokerage account as TreasuryDirect.gov doesn’t have that functionality.
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Scott Caufield, CFA, CPA