There is an old adage for investors that goes something like, “It’s not what you earn, but what you keep, that matters”. This of course relates to expenses like commissions and fees, but it’s primarily about taxes. After all, taxes are one of the few aspects of investing that you can control.

For the fixed income (bonds and cash) portion of your portfolio, tax considerations are probably more important than for the stock portion. Questions to consider include how your state of residence treats the investment for tax purposes, and what the impact of changing interest rates can be on your investment return.

For a state like Oregon which has a state income tax, different investment types are taxed differently. Interest on certificates of deposit (CDs) is normally fully taxable. Interest on US Treasury bonds is not subject to state income tax.

With the recent changes to the yield curve – with the short end rising and the long end softening – it may make sense to consider investing in Treasuries.

Earlier this month, 1-year Treasuries were yielding 2.6%, and 3-year Treasuries 2.5%. In contrast, 3-year CDs may yield 3% or more. For investors subject to state income tax, do Treasuries make sense?

Let’s look at a couple examples:

A $50,000 investment in a 1-year Treasury that pays 2.6% earns $1,300 in interest. A similar investment in a 3-year CD that pays 3% would earn $1,500 before tax, and $1,365 after tax (assuming that the tax burden is Oregon’s 9% state tax).

A $50,000 investment in a 3-year Treasury that pays 2.5% earns $1,250 in interest, on which no state tax is payable (yes, federal income tax is still owed). Again, a similar investment in a 3-year CD that pays 3% would earn $1,500 before tax, and $1,365 after tax. In this case, the CD appears more attractive, but other considerations may apply.

Future interest rates are not guaranteed, and tax rates and brackets may change.

For some investors, it may make sense to consider building a so-called “ladder” of bonds and CDs of different maturities. This is a service that an investment advisor or broker can assist with.

For many investors, maintaining a consistent maturity with their fixed income investment is more important, and in that case a bond mutual fund or exchange-traded fund is generally a better option.

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