It's worthwhile to weigh differences between CDs and T-bills

Where do you earn the most money -- in six-month Treasury bills or six-month certificates of deposit (CD)? There is little difference in their security. Both are either direct obligations of the US government (T-bills) or insured by either the Federal Deposit Insurance Corporation (FDIC), if you buy your CD from a bank, or by the Federal Savings and Loan Insurance Corporation (FSLIC), if you buy your CD from a savings and loan association.

Both are six months duration and both require at least $10,000 minimum. Finally, both depend on the Monday morning Treasury bill auction to determine interest rates.

Beyond these similarities, enough differences lurk to raise the question about which is best for you. You must examine the differences to find the optimum combination. Here's how:

* Taxes -- Interest from both the T-bill and CD are taxable at the federal level. But, only the CDs are subject to state income taxes. This difference alone could affect bottom-line yield after all taxes are paid.

* Liquidity -- Although the stated term for both the T-bill and CD are for six months, you could get out of either before maturity. Getting out of a CD could be costly; the penalty is three month's interest whether earned or not. Generally, with such a stiff penalty, owners of CDs find it less expensive to borrow against the CD using it as collateral and paying 1 to 3 percent above the interest payable on the CD. The loan is then paid off when the CD matures.

Treasury bills cannot be returned to the government prior to maturity. However, an active secondary market for T-bills exists where a T-bill may be sold to another investor prior to the T-bill's maturity. Whether the investor loses or gains from this transaction depends on the interest rates at the time of the sale. If interest rates have risen since the T-bill was originally purchased, the value of the T-bill will have dropped. If rates declined, the T-bill will be worth more. Since T-bills are traded through a broker, a commission is involved as well.

* Ease and cost of purchase -- Six- month certificates are readily available at the bank on the next corner or an S&L down the street, and there is no cost or commission exacted. This ease of purchase can be a big advantage for many persons. T-bills must be purchased from a Federal Reserve Bank or branch either in person or by mail. When either is not convenient, a bank or broker will buy T-bills for you and charge a fee -- typically from $15 to $40.

* Rate of return -- When T-bill rates fall below 9 percent, S&Ls may pay up to one- fourth of 1 percent higher interest on 6- month CDs than commercial banks. Both commercial banks and S&Ls may offer T- bill, 6-month CDs at a one-fourth of 1 percent higher rate than the discount or advertised rate for T-bills. It works like this: When you deposit $10,000 minimum for a CD, you receive the stated interest along with your initial deposit after six months. But when you buy a T-bill, you put up less than $10,000 in cash and receive exactly $10,000 back six months later. For example: An advertised (discount) rate might be 10 percent. After six months with a CD at 10 percent plus 1/4 percent, you would receive $10,512.50.

When you bought a T-bill, you would have paid $9,500 and received $10,000 six months later. The CD interest of $512.50 was $12.50 higher, but $500 as a percent of $9,500 invested in the T-bill amounts to 10.53 percent annualized. This is sometimes called the "coupon equivalent rate." If the $500 difference between the $9,500 invested in the T-bill and the $10,000 invested in the CD were invested at the same 10 percent rate, it would have earned $25. Thus, $10, 000 invested would earn $12.50 more in a T-bill.

* Flexibility -- You must buy T-bills in $5,000 increments after the initial exceeds the $10,000 minimum. Thus, you can roll over the interest after six months directly into another CD to compound growth. It's easier than taking the interest from a T-Bill and investing it elsewhere until another $5,000 is collected.

You must weigh the pros and cons of each as they apply to you.