Treasuries as a CD substitute

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The Federal Reserve Board has kept short-term interest rates low since December 2008, keeping its targeted federal funds rate at zero percent to 0.25 percent since then and promising to keep the rate at this level for the foreseeable future. The Fed board has said that it plans to keep the key short-term interest rate at this level until the unemployment rate drops below 6.5 percent. That’s not expected to happen until at least 2015.

Since the federal funds rate represents the interest rate at which banks can borrow reserves from other banks, there is not a lot of pressure on banks to attract depositors since they can borrow federal funds for free (or nearly free). Savers have suffered through low yields, watching the purchasing power of their savings decline after taxes and inflation, even though inflation hasn’t been a pressing problem since 2008.

Recent talk of the Federal Reserve “tapering” its purchases of $85 billion per month of Treasury securities and  mortgage-backed securities has caused longer-term U.S. Treasury yields to go higher. The 10-year U.S. Treasury note has seen its yield rise to about 2.9 percent from a low of 1.66 percent in early May of 2013. When interest rates go up, prices go down, causing investors in bonds to lose money.

What does all this mean to the typical investor in certificates of deposit, since most CDs have maturities of five years or less?

Here’s where things get interesting. As I post this, the five-year Treasury note is yielding 1.71 percent.

CD rates vs. Treasury maturities

Aug. 22, 2013 Bankrate national average Bankrate highest CD yield* U.S. Treasury yield**
High-yield savings 0.11% 1%
3-month 0.10% 0.45% 0.03%
6-month 0.15% 0.87% 0.06%
1-year 0.24% 1.05% 0.14%
2-year 0.37% 1.02% 0.42%
3-year 0.47% 1.40% 0.82%
5-year 0.79% 2.05% 1.71%

*Annual percentage yields (APYs)

**Source: U.S. Department of the Treasury, daily Treasury yield-curve rates

Investors willing to shop the highest national CD rates can earn yields higher than the corresponding Treasury maturity. The highest national yield on a high-yield savings account outperforms both three- and six-month CDs and Treasuries.

If investors can shop rates nationally for CDs at and get a higher yield than on Treasury securities, why get excited about these Treasury yields?

The excitement is for CD investors don’t shop nationally, because they can set up a TreasuryDirect account and buy Treasury maturities with minimum purchases of $100 and in increments of $100. For the two-, three- and five-year maturities, the Treasury note yields are higher than the Bankrate national average for CDs of that maturity.

There are some things to consider. While Treasury securities are marketable securities, the cost of redeeming one prior to its maturity date would be prohibitive and darned inconvenient for small dollar amounts of Treasury purchases. Talk about a substantial penalty for early withdrawal. You also want to consider any costs associated with the bank account that is linked to the TreasuryDirect account.

A TreasuryDirect account gives investors a local banking alternative to improve yields for longer-term savings by buying Treasury notes. Not ready to commit? Keep an eye on Treasury and CD yields, using Bankrate.

Taking the low-end yields out of play raises returns for investors and raises average yields on CDs. That’s the beauty of keeping an eye on Treasury yields when investing.

How do you approach investing in this low-yield environment?

To reach me on Twitter, visit @DrDonSays