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WHY BUY CDS WHEN TREASURIES HAVE HIGHER YIELDS?

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With certificates of deposit (CDs) at their highest yields in almost three years, investors are pouring over a billion dollars a week into CDs, according to the Wall Street Journal. My question still is "why" when you can earn even higher yields on Treasury bills and notes.

I've been writing for months now that investors should be buying Treasuries, and even considering cashing in their CDs to put their money into Treasuries. Interest rates have risen substantially for the past 10 months, making both CDs and Treasuries attractive investments, but the yields on T-bills/notes combined with their state tax exemption make them the most profitable choice.AVOID STATE INCOME TAX. Treasury bills are exempt from state and local income taxes, and CDs aren't. This effectively increases the tax equivalent yield on Treasuries and decreases the after-tax yield on CDs.

WHAT'S YOUR EXCUSE? Many investors think that it's too hard to invest in Treasuries. It isn't. The Federal Reserve Bank has made it very simple and convenient. I know that you want higher yields, but for some reason too many of you keep buying CDs. It's really quite simple. There are actually three ways to purchase them. You can get one through a stockbroker, your bank or directly from the Federal Reserve.

Since there is no reason to pay a commission on something you don't have to, I recommend going to your local Federal Reserve Bank. When you're there you tell them that you want to make a "non-competitive" bid for a T-bill, whatever maturity you desire, and then give them cash or a certified check for $10,000 or more in some multiple of $5,000. After the auction (three- and six-month T-bills are auctioned every Monday; one-, two- and five-year notes are auctioned monthly; three- and 10-year notes are auctioned quarterly; and Treasury bonds are auctioned twice a year in February and August), you will get back the "discount."

If you live in a city without a Federal Reserve Bank, you can purchase treasuries through the mail.

WHAT IF I ALREADY BOUGHT A CD? If you own CDs, it might be time to cash them in. You probably locked up your money for a longer time than you normally would have to stretch your maturities out to capture higher yields. Now, with interest rates so high, you want to take your money out and reinvest for a higher yield, but you're facing a withdrawal penalty. Well, sometimes it pays to pay. Depending on your circumstances and when you bought your CD, you could still be better off paying the penalty.

Penalties are generally six months of interest on CDs with maturities longer than one year. On a five-year $25,000 CD purchased a year ago at 2.73 percent, you would receive $682.50 in interest each year for the next four years. That's a total of $2,730 in interest payments.

Let's compare this to what you would make if you cashed in your CD, paid the withdrawal penalty, and bought a five-year T-bill yielding 7.68 percent today. You would earn $1,920 in interest each year. After subtracting $341 for the withdrawal penalty for your CD, you would still be ahead by $896.25 in the first year, and earn a total of $7,338.75 ($7,680 less $341.25 in withdrawal penalty) in four years. That's $4,608.75 more than you would have when your CD matures in four years if you don't cash it in. Sounds like a good deal to me.

STILL NOT CONVINCED? T-bills and notes aren't for everyone, but they have a lot of benefits going for them. They are considered among the safest investments available because repayment is guaranteed by the U.S. government and they are exempt from state and local income tax. If you're worried about interest rates continuing to rise, which they probably will, you can buy Treasuries from your broker and pay the commission, but then you are able to use their services in selling them before maturity. If interest rates fall, you also can sell them for a profit.

Probably the greatest pitfall of Treasury investing is the high minimum investment. There is a $10,000 minimum on T-bills, $5,000 minimum on T-notes with less than five years' maturity, and $1,000 minimums on bonds and notes with more than five-year maturities.

DON'T FORGET ABOUT MONEY FUNDS. You can still, however, get in on the action if you can't meet these high minimums. Money market mutual fund yields are also up, making even them more attractive investments than CDs. According to IBC/

Donoghue's Money Fund Report, the average money fund yield is 4.96 percent, which explains why assets in money funds are up about $40 billion this year.