For a U.S. government guarantee on your investments, the choices boil down to Treasury bonds or bank certificates of deposit. Treasury securities are backed by the full taxing power of the U.S. government. A CD in a bank is insured by the Federal Deposit Insurance Corp. The choice depends on which features are most important to you.
U.S. Treasury Bonds
The term "Treasury bonds" is often used for the full range of Treasury securities including Treasury bills, notes, bonds and Treasury inflation-protected securities. Treasury bills mature in one year or sooner, and they are sold at a discount to the face value. The longer-term notes, bonds and TIPS pay interest semi-annually.
All Treasury securities pay fixed rates of interest. However, the face value of a TIPS increases with inflation, and so will the interest payments. Treasury interest rates are determined by supply and demand in the bond markets.
Treasurys can be purchased through an investment broker, or directly from the Treasury at TreasuryDirect.gov.
Certificates of Deposit
Certificates of deposit are a type of bank savings account. A CD earns a fixed rate of interest for a set term, from 30 days to five years. You can invest in a CD at a local bank or through banks that offer CDs over the Internet. A bank sets its own rates for CDs, depending on what type and term of deposits the bank wants to attract.
FDIC insurance on bank deposits guarantees the safety of a CD up to $250,000.
Treasury Bond Advantages
The major advantages of Treasury bonds are size and term. Although a CD is insured for only up to $250,000, there is no limit on government protection for Treasury securities. Also, Treasurys are available with terms of up to 30 years, but CD terms longer than five years are rare.
Because Treasurys are marketable securities, it is possible to make a capital gains profit on them if bond values increase. Treasurys also have a tax advantage over CDs: Interest earned from a Treasury bond is exempt from state income tax.
Because individual banks set their own CD rates, some shopping around will find the best rate, which might be higher than the rate for a Treasury security of comparable maturity. Treasury rates are market-driven, while CD rates are set to attract customers.
A CD also allows you to let the interest earnings compound into the value of the certificate. Treasury bonds pay out interest twice a year without the benefit of compounding. Treasury bond interest piles up in your bank or brokerage account unless you make an effort to invest that money.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.