Taxes vs. Safety vs. Liquidity: Picking the Perfect Fixed-Income Fit

Taxes vs. Safety vs. Liquidity: Picking the Perfect Fixed-Income Fit

April 04, 2024

With inflation soaring in 2022, the Fed was forced to raise interest rates furiously to try and address skyrocketing prices. As a result, it created an opportunity for investors to consider fixed instruments that previously had not looked as attractive.

US Treasuries and Certificates of Deposits (CDs) are both great options that offer fixed rates of return and predictable income. Which one makes more sense when it comes to investing?

Most investors will certainly think about the interest rate, or yield, that the investment will pay. With the recent rising rates, current yields are at levels we have not seen for the past twelve to fifteen years. Currently, CDs and Treasuries that mature in one year or less have approximately the same interest or yield of 5.3%.  When considering the next two to five years, CDs hold a slight advantage.  

If rates are the same, or somewhat close, tax considerations can play a role in your decision making. Treasuries are taxable at the Federal level but exempt from state income tax. CDs are taxable at both the Federal and state level. If investing in a tax-sheltered account, such as an IRA, the tax consideration does not matter since funds will be deferred. However, if investing in a taxable investment account, state income tax considerations may sway an investor toward Treasuries to obtain an overall higher after-tax return on their investment.

Other factors that an investor should consider are safety of the investment, and the liquidity of the holding. CDs are issued by banks and are Federally insured by the FDIC, up to $250,000 per bank, per person. Treasuries are issued by the US Treasury Department and are backed by the full faith and credit of the US Government. Both are high-quality investments, and designed to protect principal, and pay a stated interest over the time of the holding. If an investor had more than $250,000 to invest in CDs, they would need to make sure they were utilizing multiple CDs from different banks to stay within the limits of FDIC insurance. With Treasuries, an investor could buy just one for more than $250,000 and still have the backing from the Government.

While possible to sell or break a CD early, the availability and market to do so is generally more limited than it is with Treasuries. Treasuries are the most active and liquid market in the world. As a result, trying to sell your note before maturity is often easier, and comes with better pricing than one might get with a CD. In either case, you could still see a decline in value if you choose to sell your CD or Treasury early, depending on what rates were when you purchased the investment, to when you sell the investment. As an example, assume a two-year CD or Treasury was purchased with a rate of 5%. If one year later, the investment was sold, and current Treasuries or CDs are paying 6%, the value of the 5% investment is less valuable and less attractive. Therefore, it would command a lower selling price from when it was originally purchased.

The suitability of either of these options depends on various factors specific to your financial situation and goals. Please consult with your financial advisor for further guidance as it relates to your specific situation.