Comparing CDs vs Bonds
What Are the Best Choices for Safe Income?
If you want to get a return on your savings but also want a low-risk investment option, certificates of deposits and bonds are two good choices.
Both allow you to get some interest payments on your cash beyond what you earn from standard savings and checking accounts, but each security has its own characteristics that may or may not meet your investing needs.
Risk and Liquidity
Generally speaking, bonds and CDs are considered “safe” investments because they offer a steady income without the volatility of stocks. For older people who want to preserve their savings during retirement, these are good vehicles.
Most people find bonds to be slightly more lucrative overall, but they can come with more risk. Depending on your age and how soon you need access to your money, you may find one to be preferable over another.
In terms of liquidity, once you lock your money up in a CD, you can't take it out without paying a penalty. Banks have recently started offering CDs with penalty-free early withdrawals, but they're subject to specific rules and you'll receive a lower interest rate on this type of CD.
Bonds, on the other hand, are much easier to convert back to cash without paying any penalty.
CDs and Interest Rates
Certificates of deposit are not much different than a savings account. With CDs, you are simply putting money in the bank and agreeing to not withdraw it for a set period, in exchange for a higher interest rate. The longer you are willing to have your money tied up, the higher interest rate you will get. CDs are insured by the Federal Deposit Insurance Corporation (FDIC), just like other bank deposits, and thus there is a virtual guarantee you won’t lose money. In an environment of rising interest rates, CDs offer higher rates as well.
When interest rates rise, that’s generally a good thing for those considering putting money into CDs. Higher interest rates mean more income, after all. It may be disadvantageous to put money in a long-term CD if interest rates are rising quickly because you might be locked into one rate and miss out on the chance to make more money if rates go up.
That’s why many investors set up “CD ladders” in which they place money in various CDs with different maturity dates. This way, they never have all of their money tied up all at once.
Bonds and Interest Rates
Bonds are a little bit more complicated than CDs. With bonds, you are essentially lending money to a government or a business in exchange for interest payments over the course of a predetermined period. Bonds can give you good interest income but can lose value if rates go up.
If you own a 20-year bond with a rate of 3 percent, for example, it may be less attractive to a potential buyer if interest rates rise to 3.5 percent. This may not be too big a deal if you are in short-term bonds, because interest rates usually don’t change dramatically in a short period of time. But long-term bonds may be less attractive under this scenario.
The interest you'll make on a bond is affected by market interest rates, just like CDs. However, bonds move inversely to the market, so as interest rates rise, bonds pay lower rates.
A Search for Safety
Anyone putting money in CDs or bonds is most likely interested in capital preservation. They want to know their money is safe and they're willing to take a lower interest rate in exchange for the low risk.
CDs are generally safer than bonds because they are not much different than simple savings accounts, and there’s an FDIC guarantee for anything under $250,000. The only real risk to losing money on a CD is if inflation quickly and outpaces interest income, but that risk is very small because CD interest rates are designed to track the consumer price index.
Bonds can be almost equally safe, but it very much depends on the type of bond and the creditworthiness of the borrower.
U.S. Treasury Bonds, for example, are considered extraordinarily safe investments because the United States never defaults on its debt. There are even Treasuries, known as Treasury Inflation Protected Securities (TIPS) that are indexed to inflation.
Corporate bonds from very large and stable companies are usually fairly safe, as well. But if you are seeking higher rates from bonds, you may choose to purchase bonds that are labeled “non-investment grade,” which means they carry some risk that the borrower will not be able to pay back lenders.
Short-Term vs Long-Term
Determining whether to put your money in CDs or bonds can depend on your time horizon and the current interest rate environment. As of January 2019, short-term bond yields are slightly lower than the rates offered on CDs, making CDs a better investment.
As interest rates rise, bond values go down. That’s why fewer investors have purchased long-term bonds as interest rates have been climbing steadily upward.
Considering Other Investments
Before putting money in CDs, it is worth asking whether there are other investment options out there. Interest rates are still historically quite low, and investors may be able to get higher returns from stocks.
Those concerned about the volatility of the stock market may still be drawn to dividend-paying stocks that offer relatively stable share value but income that is considerably higher than CDs or bonds. There is always risk in owning stocks, but younger investors who are far away from retirement may find them to be more useful investments than bonds or CDs.