Key takeaways
- CDs and bonds typically represent low-risk options for individuals looking to save money while earning a consistent interest rate and broadening their investment portfolio.
- CDs generally accrue interest that compounds until they reach maturity, whereas bonds often distribute interest payments at fixed intervals over their duration.
- Many certificates of deposit come with significant penalties for early withdrawals, whereas bonds can theoretically be resold prior to their maturity date on secondary markets.
Certificates of deposit (CDs) and bonds are both favored by savers because they're low-risk investments That might offer somewhat better returns compared to conventional savings accounts. In the case of certificates of deposit (CDs) and bonds, your funds are usually locked away for a specific duration in exchange for a guaranteed interest rate.
Even though these two kinds of investments share numerous similarities, various essential distinctions must be taken into account when deciding which one suits you best.
What are CDs?
A A CD is a type of deposit account. That typically offers a consistent annual percentage yield (APY) in return for keeping your funds locked down for a specific duration. CD terms usually span between three months and five years, with longer durations potentially offering higher returns compared to shorter ones.
CD yields often vary alongside the The Federal Reserve's key interest rate As a result, the amounts paid out by numerous certificates of deposit (CDs) have risen since the Federal Reserve started significantly boosting interest rates in February 2022. However, recently, many banking entities are starting to reduce their highest-yield CD rates in preparation for what the Fed might do next. lowering interest rates At its subsequent gathering on September 18.
How safe are CDs?
CDs are regarded as a secure investment because they offer a fixed interest rate—and your money is safeguarded against bank failures when your CD is insured. Federal Deposit Insurance Corp. (FDIC) or the National Credit Union Administration (NCUA).
The funds are protected by the FDIC up to $250,000 for each depositor at every FDIC-insured bank within different ownership categories. Similarly, the NCUSIF guarantees up to $250,000 for individual accounts in credit unions.
A factor that could adversely affect the fixed rates of certificates of deposit (CDs) is inflation . Funds locked into a certificate of deposit might decrease in value over time if the inflation rate exceeds the interest rate.
Withdrawing from a certificate of deposit prior to the end date typically leads to an early withdrawal penalty The duration of the certificate of deposit (CD) typically correlates with the severity of the penalty for withdrawing funds prematurely. This charge is generally calculated according to the CD’s interest rate. As an example, withdrawing your money before maturity could result in forfeiting anywhere between 90 to 180 days' worth of accrued interest.
At what point should one opt for a CD?
A CD with a fixed term and guaranteed rate can be a good place for money you plan to spend down the line, such as a wedding, or the purchase of a house or car. Due to early withdrawal penalties, however, the money is not as easily accessible as funds in a savings account. This makes a liquid savings account a better option for money you may need for emergencies Or other acquisitions in the near future.
Unlike bonds, a CD’s fixed term is guaranteed to pay a specific yield on a set date in the future. You can use a CD calculator to determine exactly how much interest you’ll have earned when the CD matures.
Since CDs generally offer fixed returns, they might be a wise choice when interest rates are declining. During such times, you could secure a better yield now compared to what would be available in the following months or years as rates drop.
What are bonds?
By investing in a bond, you're essentially lending money to either the government or a corporation that issues the bond. As compensation, you get periodic interest payments throughout a specified period.
Bonds are frequently seen as essential. part of a varied investment collection Since they generally pose less risk compared to stocks. However, this reduced risk comes with the downside of expecting a smaller return.
Kinds of bonds encompass Treasury securities, savings bonds , municipal bonds and corporate bonds .
You can opt to buy individual bonds, or decide to put your money into bond mutual funds instead. exchange traded funds (ETFs) You can purchase government bonds directly from the U.S. Treasury, thereby bypassing the fees typically charged when using a broker.
How safe are bonds?
You can end up losing the investment you made in bonds through various means. Should interest rates increase significantly, offloading a bond prior to its maturity date could result in receiving less than what you originally paid. However, you should expect to receive the face value of the bond when it reaches its maturity date.
A bond might lose all its value if the issuer fails to make payments—like what happens when a firm declaring bankruptcy issues bonds. Therefore, opting for investment-grade bonds could be beneficial; these receive favorable ratings from credit-assessment firms. Nonetheless, securities like Treasury bonds and U.S. savings bonds are supported by the complete assurance and commitment of the federal government.
Similar to how CDs function, bonds offering a set rate of return may also experience negative effects due to inflation , as the buying power of the bond’s interest payments could decrease if inflation rises.
A substitute for fixed-return bonds can be U.S. government-issued securities. Series I bonds These investments safeguard your capital by accounting for inflation adjustments. Their returns increase and decrease in line with the pace of inflation.
When to choose bonds
Investors seeking to broaden the variety within their investment portfolio might choose to allocate a specific portion of their funds into bonds, as these typically come with less risk compared to equities. retirement As it draws closer, some opt to increase their bond investments in hopes of achieving a stable returns with minimal risk of capital loss.
CDs vs. bonds
Here’s a side-by-side comparison of CDs and bonds illustrating where they can be purchased, how your investments are secured, and their liquidity.
| CDs | Bonds | |
|---|---|---|
| Issuer | Banks or credit unions | Governments, municipalities or corporations |
| Purchase method | Purchased individually | Bought separately or as part of an ETF or mutual fund |
| Term lengths | Months to years | Years to decades |
| Rate of return | Fixed rate with compounded interest (the most typical option) | Fixed rate with periodic interest payments (most typical) |
| Safety | For CDs backed by the FDIC or NCUA, deposits are protected up to $250,000 per depositor at each insured bank, varying by type of account ownership. | Treasury securities and U.S. savings bonds are guaranteed by the federal government, making them quite low-risk. In contrast, corporate bonds depend on their issuing companies for backing and come with the potential loss of capital should the firm fail financially. For optimal strategy, focus on corporate bonds offered by entities holding strong credit ratings. Municipal bonds, meanwhile, rely on local governments like cities, counties, states, or similar municipalities that have issued them; although typically secure, these can face default risks if the municipal issuer declares insolvency. |
| Minimum investment requirements | It depends on the issuer but typically falls between $0 and $1,000. | Typically, individual bonds have a starting point of $1,000; however, when buying bonds via an ETF or mutual fund, there can be lower investment minimums. |
| Liquidity | Most certificates of deposit come with early withdrawal penalties, usually ranging from 90 to 180 days' worth of interest. | Bonds come with maturity dates; however, many of them can be traded earlier through secondary markets. |
Even though CDs and bonds share some common traits—both being low-risk investment options that typically offer a set interest rate—they each come with distinct characteristics that might influence your decision when picking one over the other:
Safety
Typically, both certificates of deposit (CDs) and bonds tend to be secure investment options. Nonetheless, when you opt for a CD backed by insurance from either the FDIC or the NCUA, your funds are protected against loss even if the banking institution encounters failure.
Treasury bonds and U.S. savings bonds Are supported by the federal government. In contrast, this isn’t the case with options like corporate bonds. To reduce the risk of financial loss, consider selecting bonds that have received an investment-grade rating from credit-assessment firms.
Minimum investment requirements
If your investment budget isn't large, you might come across a CD that has a minimal initial deposit requirement — for example, Citibank , which only needs a starting balance of merely $500. Other financial institutions, like Synchrony and Capital One requires no minimum deposit to open a certificate of deposit (CD).
The stated value of bonds may differ depending on the bond type and their maturity date. Certain corporate bonds could Treasury bonds For example, they have a minimum face value of $1,000 — this is the amount you will pay to purchase the bond.
A method to bypass paying a significant minimum face value for a bond involves investing in bond ETFs This includes a collection of bonds. You can acquire a single share in a bond fund at its market price—moreover, certain brokers permit buying partial shares as well.
Liquidity
Most of the money in certificates of deposit (CDs) can’t be withdrawn before they mature without facing an early withdrawal penalty. Although bonds have a similar maturity date, you might be able to sell them in the secondary market prior to their maturity date.
In the end, money that you might require accessing soon—like for emergencies—is perhaps better stored in a readily accessible savings account, like a high-yield savings account .
Bottom line
Both certificates of deposit (CDs) and bonds are typically considered secure investment options, and each can contribute to diversifying a portfolio that includes more volatile assets like stocks. Additionally, CDs and bonds might offer a somewhat higher return compared to conventional savings accounts. savings accounts —and when deciding between the two options, it's crucial to take into account aspects such as safety, minimal investment thresholds, and liquidity.
–Freelance writer Drew Waterstreet contributed to updating this article.
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