CDs vs. Bonds: Differences And Pros & Cons of Each

If you’ve got a pile of money that you’re looking to invest, and you want to ensure that your money isn’t going to vanish with a volatile market, both CDs and bonds could make solid additions to your investment portfolio. Both are a type of fixed-income investment, which guarantee a certain return on your investment once they come to maturity.

But which is better: bond or CD? This depends on several factors, including how long you want your money invested, whether you think you might need to access your funds prior to the maturity date, and whether you expect the market to improve, decline, or stay relatively stable during the life of your investment.

Certificates of deposit

A certificate of deposit (CD) is a special type of savings account where you deposit a fixed amount of money for a predetermined period of time in exchange for a fixed annual percentage yield (APY). Essentially, you’re sacrificing ease of access to your money for the term (anywhere from a few months to a few years) for an increased return on investment.

When a CD matures, you’re given back your initial investment along with all of the interest your deposit accrued over the course of the account’s life. If you absolutely need to, you can get access to money in your CD before its maturity date, but you’ll have to pay an early withdrawal penalty.

Early withdrawal penalties differ depending on the financial institution managing your CD, but they’re typically expressed as a period of accrued interest. For example, the penalty you pay may be equal to “nine months’ interest.”

Interest earned in a CD

The interest rate you receive for your CD will depend on what institution you choose to use and the term of your CD. Rates also change daily, so it’s a good idea to keep an eye on market trends. If rates are going up, it may be worth your while to wait to invest in case you can get a better rate.

To get a better idea of the interest rates available for CDs, take a look at some of the CD accounts offered below.

Pros and cons of CDs

Before investing in CDs, or any investment vehicle for that matter, make sure you consider the benefits and risks that come with the territory.

Bonds

A bond is, at its essence, an IOU agreement. When you purchase a bond, you do so with the understanding that you’ll receive predetermined interest payments for the duration of the bond’s life. Once the bond matures, you’ll receive your principal investment as well.

Similar to CDs, bonds’ interest rates are typically much higher than a standard savings account. This is because the bond issuer knows they will have a predetermined period of time to repay the money. Interest rates paid on bonds vary day-to-day, which could expose you to interest rate risk. However, they’ll also be different depending on what type of bond you purchase, and the duration of the bond’s life.

There are three main types of bonds, which differ based on the entity from which you purchase them.

1. U.S. Treasury bonds

Bonds purchased from the U.S. government are known as U.S. Treasury bonds. These are one of the safest types of investments, as they are backed by the credit of the federal government.

Treasury bonds tend to be long-term investments that mature after 30 years and pay interest every six months.

2. Municipal bonds

Municipal bonds are purchased from a state, county, city, or other municipality. They tend to be quite safe as well and can be broken down into three subcategories:

1. General obligation bonds. These are unsecured bonds that aren’t tied to any specific assets. Instead, they are backed by the “full faith and credit” of whoever issues them. Because state and local economies are relatively stable, these can still be safe investments.
2. Revenue bonds. These bonds are backed by revenue generated from specific projects, such as highway tolls or parking fees. Some revenue bonds are “non-recourse,” which means that if the project backing them fails to generate enough money, the bonds don’t have to be paid back.
3. Conduit bonds. Conduit bonds are issued by municipalities on behalf of a third-party entity, such as a nonprofit college or a hospital. The third party is responsible for paying back these bonds to the issuer, who pays the interest. If the conduit borrower fails to repay the money, the issuer usually won’t have to pay back the bonds.

3. Corporate bonds

Corporate bonds are issued by companies in order to raise revenue. These can be somewhat risky because if the company fails you may not be able to recoup your initial investment.

Bond prices are determined by the market in which they’re purchased. If things are going well economically, selling bonds on the secondary market is likely to fetch you a higher price for them than you initially paid. However, if markets are struggling, bond prices decrease.

Pros and cons of bonds

As with CDs, take some time to review the benefits and drawbacks of bonds before investing in them.

If you think bonds may be the right investment option for you, consider speaking to one of the brokerages below, each of which handles bonds.

CDs vs. bonds: What’s the difference?

At the very heart of things, bonds and CDs are quite similar: They are both forms of relatively safe, long-term investments. There are, however, some important distinctions between CDs and bonds that you should be aware of before deciding which to purchase.

CDs vs. bonds: Which is right for me?

CDs are likely better options if you’re looking to capitalize on earned interest for a few years in order to save up for a larger purchase (like buying a home). The bank or credit union that issues the CD guarantees a certain rate of return on your investment. You also don’t have to worry about losing out on interest in a strong market over the course of a 30-year contract.

Bonds, on the other hand, may be a better choice if you want to squirrel away money for a long time down the road. The classic scenario here is being gifted with savings bonds at birth by your grandparents, which you would cash in 18 years later to attend college or 30 years later to buy your first home.

FAQs

Are bonds better than CDs?

While this isn’t always true, there are some cases where a bond is “better” than a CD:

• You want to invest your money for a longer duration (up to 30 years).
• You want the flexibility to sell off your investment on a secondary market before it matures.
• You want to support a municipality or company that you believe in.

Are bonds or CDs safer?

Technically, CDs are safer because they’re insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 if you buy them from a bank. If you purchase CDs from credit unions, the National Credit Union Administration will insure you for the same amount.

Both bonds and CDs, however, are considered relatively safe investments. It’s unlikely that the federal government will default on bonds it issued. (Corporate and municipal bonds, on the other hand, are somewhat riskier.)

How much will a $10,000 CD make in a year?

It’s difficult to give an exact number because each CD will have a different interest rate. So let’s say you purchased a one-year CD with an interest rate of 3.5%. Using this rate, a CD with a $10,000 initial investment will yield $350.

Is it a good time to buy I bonds?

I bonds are a type of bond issued by the federal government designed to protect the purchaser from inflation. I bonds do this by splitting the earned interest into two parts. One part is fixed at the date of purchase, while the other changes every six months based on the current market. In this way, you’re guaranteed a certain amount of interest returned to you while allowing for another portion of the earned interest to grow with the market.

Because bonds have such long lifespans, protecting yourself from inflation might just be a great idea, especially these days. However, it’s hard to predict the economic landscape six months from now, let alone 5, 10, or 20 years in the future. You should always consult an investment professional before making the choice to purchase any type of bond, including an I bond.

Ben Coleman

Ben Coleman is a veteran English teacher with a knack for translating complex concepts into bite-sized chunks. Having recently dug himself out of crippling credit card debt, he’s passionate about providing excellent financial resources to folks who need them so they don’t end up in the same position. Ben writes for SuperMoney from Rochester, NY where he lives with his wife and dogs (Yoshi and Pig).