Businesses and municipalities with significant cash to invest typically look for the best rates, the most safety, and the most accessibility. With these goals in mind, leaders often must decide between Certificates of Deposit [CDs] and Treasuries for business cash reserves.
While these two types of investments offer similar benefits in terms of safety, there are some key differences that decision makers need to understand before committing to an investment. In addition, organizations can secure competitive rates without sacrificing safety by choosing the right investment vehicle and partnering with an experienced company that specializes in cash management solutions.
Similarities Between Treasuries and CDs
CDs and Treasuries share some key characteristics. Both investment vehicles are purchased for a specific term, offer fixed interest rates, and are generally considered safe investments for an organization’s cash. While there are also key differences between these types of investments, it can be valuable to first understand how they are similar.
CDs and Treasuries Are Purchased for a Set Term
CD terms can range from 1 month to 5 years with a multitude of options between those maturities. Similarly, Treasuries are issued for a specified length of time, typically between 1 month and 30 years. These terms are one of the factors that determine yield. In general, CDs and Treasuries with longer terms have higher yields than shorter term investments, but that is not always the case.
The variety of terms offered by CDs and Treasuries allow investors to balance their liquidity needs with their required rate of return. Additionally, both CDs and Treasuries allow investors to implement a “ladder strategy” with their holdings that can offer some key advantages. This involves purchasing multiple CDs or Treasuries with staggered maturity dates so that cash is available when it is needed and working when it is not.
Rates for CDs and Treasuries Are Fixed
When an organization buys a CD or a Treasury security, they know the rate of return they will earn throughout the life of the investment. This can be a determining factor for many organizations seeking safe and predictable income from their cash holdings.
While interest rates are fixed after purchase, yields on newly issued CDs and Treasuries vary according to market factors and interest rate policy. Typically, Treasuries are very sensitive to changes in the Fed funds rate. On the other hand, there are several factors that determine the rate banks pay for deposits, so CD rates may react more slowly to changes in interest rate policy. This can lead to less volatility in CD markets compared to Treasuries.
CDs and Treasuries Offer a High Degree of Safety
Both CDs and Treasuries are considered safe investments. Treasuries are backed directly by the federal government, while CDs are covered by FDIC insurance. This insurance is also backed by the full faith and credit of the U.S. government and provides assurance that depositors’ funds are protected from bank failure. In fact, no depositor has lost a penny of FDIC-insured funds since the FDIC was founded in 1933. This makes both CDs and Treasuries some of the very safest investments available.
As organizations search for investment options that provide safety as well as a competitive return, CDs and Treasuries can both appear as similarly attractive options. However, there are some key differences between these investments that should be understood before committing to a long-term investment strategy.
Differences Between CDs and Treasuries
While CDs and Treasuries have some similarities, they also have important differences. One of the clearest distinctions between CDs and Treasuries is their processes for early withdrawals.
Accessing Funds Before Maturity
If held to maturity, both CDs and Treasuries return the principal and any accrued interest to the investor. However, if an organization needs to access their funds prior to maturity, the process differs between CDs and Treasuries. With CDs, an organization would request a redemption from the issuing bank and their funds would be returned to them less any early withdrawal penalty owed. On the other hand, if an organization needs to access the funds they invested into Treasuries, they must sell the securities on the secondary market.
CDs often have early withdrawal penalties of 3-6 months’ interest. This penalty is stated in the CD agreement, so the investor is aware of the consequences of withdrawing their funds prior to maturity. On the other hand, bonds must be sold on the open markets to access their funds prior to maturity and the resale value of a bond can vary dramatically during the bond term. That fact can put an organization’s principal at risk if they need to access their funds prior to maturity.
Certain Situations Can Lead to Principal Loss
Interest rates are one factor that can impact the resale value of bonds because bond yields and prices are inversely related – as yields for newly issued Treasuries rise, resale values for existing Treasuries fall. For example, a 30-year Treasury, issued on February 15, 2022, with the CUSIP 912810TD0 was sold in $100 increments. On June 30, that bond was valued at 82.843750 or $82.84, representing a $17.16 (17%) loss if it were sold. If an organization purchased this bond at issue, and needed to access their funds on June 30, they would have been forced to liquidate at a lower value, therefore losing a significant amount of their investment.
While Treasury prices can vary significantly over the term of the bond, CDs don’t lose value based on market conditions. This can provide an additional level of comfort for organizations investing in CDs because leaders know that their principal is not impacted by market fluctuations.
Average Rates of Return Differ for Similar CDs and Bonds
Organizations often place the most focus on the amount of interest they will earn on their investments. CDs and Treasuries both offer competitive interest rates, but in many cases, CDs can offer better rates than Treasuries of similar maturity.
When comparing weekly averages from June 2009 to March 2021, 1-month CDs offered higher rates than 1-month Treasuries in 52% of those weeks. Similarly, from May 2009 to March 2021 6-month CDs outperformed 6-month Treasuries 61% of the time and 1-year CDs outperformed 1-year Treasuries in 56% of weeks. On the other hand, the 5-year Treasury outperformed the 5-year CD in 74% of weeks over the same time period, demonstrating that longer term bonds tend to perform better than CDs of similar term. However, these values only refer to national averages. Since CD rates vary by bank, there are opportunities for organizations to invest in CDs that earn better than average returns.
The rates that banks offer their customers depend on many factors including bank structure, individual bank needs, geography, and competition. This gives organizations the ability to invest with banks that pay higher than average rates by shopping the market. In the past, finding banks that offer competitive rates has been a time-consuming task, but with fintech this process is now easier than ever.
Partner With the Cash Management Specialists at ADM
Our Company, the American Deposit Management Co. [ADM] connects organizations seeking safety and competitive returns for their cash reserves with our nationwide network of banks and credit unions that need deposits. These financial institutions compete for deposits by offering their most competitive rates, so with ADM, it is easy to optimize the return on CD investments. In addition, our proprietary fintech allows organizations to receive extended FDIC / NCUA protection for all their funds.
When managing an organization’s cash, it takes more than safety and a competitive return. Leaders need to partner with a company they can trust, and ADM is that company. Our team is our secret sauce, and you’ll understand that when you work with us. To speak with one of our knowledgeable, friendly cash management specialists, use the chat feature at the bottom of your screen or give us a call.
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*American Deposit Management Co. is not an FDIC/NCUA-insured institution. FDIC/NCUA deposit coverage only protects against the failure of an FDIC/NCUA-insured depository institution.