Comparing Investment Yields
By: Kurt J. Konek, CPA

The volatility of the stock market has steered many investors towards securities with a fixed rate of return. To complicate matters, fixed interest rate investments are offered with varying yields and income tax implications. A commonly asked question is how do you compare the yields of a taxable and tax exempt investment to decide which has the best return on investment? This is illustrated in the following example:

If an investor is in the 25% federal income tax bracket and has an opportunity to invest in either a tax free municipal bond with a 3% yield, or a certificate of deposit paying 3.5%, which investment produces a greater after-tax return? To answer the question I would use the following formula.

Tax Equivalent Yield = Tax free yield / (1-tax rate)

OR

Tax Equivalent Yield= 3% / (1-.25)

The tax equivalent yield in this example is 4%. This means that the taxable investment, the certificate of deposit, would need to earn 4% to equal the 3% rate of return offered on the tax-exempt investment.

If you have questions on how to compare the returns on different investment opportunities contact your local CPA.