If you have some extra cash that you want to put into a low-risk investment, there are a number of choices. Two of the best investments offering no risk to the principal and competitive returns are T bills and CDs. Treasury bills are a popular option due to their attractive returns as a result of the Fed rate increases, while CD rates have also risen recently.
While both these savings vehicles could be a good addition to your portfolio, it is important to understand the differences and the specifics of how they work to determine which is best suited to helping you reach your financial goals. So, here we’ll perform a T bill vs CD comparison to help you make an informed investment decision.
The T-Bill Basics
T bills or to give them their full name, Treasury bills are short-term securities that are issued by the U.S. Treasury. This means that they are backed by the federal government, so you can have the reassurance that your investment principal is safe. T bills have terms that vary from four weeks to 52 weeks and they are typically sold in $100 increments.
When you purchase a treasury bill, you are essentially lending money to the U.S. government. These bills are often sold at either face value (at par) or at a discount. When the bill reaches the maturity date, you will receive the face value. This means that you receive a return on your investment by purchasing the bill at a discount and then receiving the full value at maturity.
The specific return you can expect will depend on how much you are investing and how long the investment will be held. For example, if you purchased $1,000 of treasury bills with a maturity date of 26 weeks and a 5% APY fixed interest rate, you would actually pay $975 and when the T bills mature, you would get the full $1,000 back.
You can purchase T bills through the TreasuryDirect portal or via a brokerage or bank.
Pros and Cons of T-Bills
Treasury bills can be a solid choice if you’re looking for a fixed-rate, low-rate investment that doesn’t require leaving your money tied up for an extended period. The maximum investment period for T bills is typically one year.
Your rate is still locked in until maturity, which means that you could miss out on higher rates if the market continues on an upswing. However, it is possible to sell T-bills before the maturity date without a penalty.
The CD Basics
CDs or Certificates of Deposit are a common form of deposit account that allows you to earn a fixed rate of interest over a specified term. CDs are available with terms that vary from one month up to several years. Typically, the highest rates are offered with the longest terms and the largest balances, but some financial institutions have promotions for different terms.
You can access your funds before the CD maturity date, but in most cases, there is an early withdrawal fee. However, there are exceptions to this with some CDs offering slightly lower interest rates and no penalty for making a withdrawal.
Most banks and credit unions offer CDs and when you open an account, you can choose the length of the term and the amount you want to deposit. In some cases, the financial institution may have a minimum deposit requirement, but many allow you to open an account with just a dollar. You may even have access to preferential terms if you already hold a bank account with that financial institution.
The interest rate on the CD is locked in when you open the account and it will remain at this rate for the entire term. The exception to this is “bump up” CDs which allow you to bump up the rate once during the CD term if market rates have increased. Upon maturity, you can withdraw your funds plus the interest earned or roll your funds over into a new CD.
Pros and Cons of CDs
The main advantage of certificates of deposit is that you will be rewarded with higher rates for holding your money in the account for longer. Additionally, since the rate is fixed for the entire term, if the rates fall during your CD term, you will continue earning the higher rate. Provided that you stay under federal limits, you will have no risk to your principal.
The main drawback of CDs is that you are locking your money in and the rate may not be able to keep pace with inflation, particularly if you open a long-term CD. If you want to minimize this risk, you will need to employ strategies such as CD laddering to have the option to access your funds periodically or switch to a CD with a higher rate.
Many people find organizing CD laddering a little overwhelming and you need to feel confident that the interest rate landscape will continue on its current trajectory.
T Bill vs CD: Which One is Best?
While they may appear similar, there are some key differences between treasury bills and CDs that will help you to determine which one is best for you.
Both T bills and CDs are considered fixed-income, short-term investments that tend to be preferable for those with risk aversion and may need to liquidate their capital. When you buy T bills via TreasuryDirect, you need to hold the investment until maturity. However, there is the option to transfer your T bill to a broker which will allow you to sell it on the secondary market. It is important to note that there are no guarantees that you will be able to recoup your full investment if you pursue this. If the rates have dramatically changed since you purchased your treasury bill, you may have difficulty finding a buyer willing to offer close to the face value of your bills.
You can liquidate your CD before it matures but you are likely to incur a penalty. Unless you’ve invested in a “no penalty” CD, there will be a penalty, but the specific amount will depend on the product. Many financial institutions calculate the early withdrawal penalty as the number of days of interest according to the original term of your CD. These penalties are weighted with larger penalties for longer-term CDs. In some cases, the penalty fees may wipe out all of the interest you’ve accumulated on your account.
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This is one area of comparison where the main difference between products is highlighted. The interest income on treasury bills is typically exempt from both state and local taxes. The gains are subject to original issue discount (OID) rules. According to the IRS, OID can be treated as zero if the total OID is less than 0.0025% of the stated redemption price at maturity when multiplied by the number of full years from the original date of issue to maturity. This is known as the de minimis rule.
The interest payments on CDs are fully taxable at the ordinary income tax rate. This means that there are no tax benefits for CDs.
This is an area where certificates of deposit may have the edge for those with a tighter budget. The minimum T bill investment is $100 and bills are sold in $100 increments. Additionally, some brokerages have an upper investment limit of $1 million.
CDs tend to be a little more flexible, as they are similar to regular bank accounts. While some financial institutions have a minimum deposit of $100 to $1,000, there are others with no minimum opening deposit requirements. Additionally, you are not tied to deposit money in specific increments. This means that if you want to deposit $987 into a CD, you don’t have to round your fund up or down as you would with treasury bills.
However, both products don’t allow additional funds to be added. If you want to invest more, you’ll need to either purchase more T bills or open another CD account.
If you’re risk averse and want an investment where your principal fund is not at risk, both T bills and CDs are worthy of consideration. However, you will need to think about what you are looking for in your investment to determine which is the better choice for you. Many people prefer the reassurance of treasury bills since you are essentially loaning money to the US government. But most CDs have federal insurance, so if the financial institution fails, you’ll be able to recoup your initial investment. Additionally, both products offer some liquidity options.
The key deciding factors are likely to be the tax implications and current rates. T bills do offer tax support which is not available with CDs. This could add up to a significant amount if your investment generates sufficient income. So, unless the current CD offerings are available with significantly higher interest rates or you want to invest a sum that is not suitable for $100 increments, treasury bills are likely to be the better option for you.