Ask Matt: Are CDs or Treasuries riskier for investors?

ByABC News
February 28, 2012, 7:54 PM

— -- Q: What's riskier for investors, certificates of deposit or Treasuries?

A: What's heavier? A big rock or a boulder? What's sweeter, a Cadbury Dairy Milk or a Hershey's chocolate bar?

What you're asking, is pretty much splitting hairs. Both CDs and Treasuries are often targeted by those who don't want to risk any of their assets since they're both pretty low on the risk scale.

Don't think either is risk free, though. Both CDs and Treasuries have risks and those risks may be rising. More on that later.

The risk of default is something you don't really have to worry with CDs or Treasuries. If you stick with CDs from banks that are protected by the FDIC, your deposits are protected by the federal government. But you must adhere to the strict rules about account sizes.

Similarly, Treasuries are backed by the full faith and credit of the federal government. So, with both CDs and Treasuries, you don't have to worry about getting paid back, as long as the federal government has money.

But does that mean CDs and Treasuries are free of risk? Absolutely not. Both CDs and Treasuries are subject to interest rate risk, which is a risk many investors have forgotten about, says Kate Warne, market strategist at Edward Jones.

Investors who either buy CDs or Treasuries will, most likely, receive the interest rates that were promised to them. The big risk is that the purchasing power of those interest payments may not be nearly as high as it is now.

Take the 10-year Treasury, for instance. Investors who buy 10-year Treasuries currently only get 2% yields. If inflation hovers around 3% a year, on average, that means the investment will lose a percentage point of purchasing power at the end of the year. The same goes for CDs. Even a five-year CD from online banks, such as ING Direct, currently yields just 1%. That's not enough to keep savers ahead of inflation.

Attached to inflation risk is interest rate risk. If the Federal Reserve eventually allows short-term interest rates to rise, which wouldn't be hard to imagine, that would push the value of Treasuries down. Many investors are so used to being in a period of falling rates, they forget that rates can, and have, steadily increased during long periods in the past, Warne says.

The longer the term of the Treasury, or CD, the riskier it is due to inflation and interest rate risks. If you want to get the least risky investment, you'll want to only put money in very short-term Treasuries or CDs.

But if you're going to go for short-term CDs and Treasuries, you might be better off putting your money in high-yield savings account. That way you get the protection of FDIC coverage and can reduce your interest rate risks, too. Just don't expect much of a return.

You can research the rates on savings accounts and short-term CDs at USATODAY.com.

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies and Fundamental Analysis for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Follow Matt on Twitter at: twitter.com/mattkrantz