CDs vs. Bonds
Certificates of deposit (CDs) and bonds are both considered relatively safe investment options to build your retirement fund. CDs pay out interest earnings in a lump sum while bonds offer a steady stream of income through coupons. But there are key differences between CDs and bonds, which may make one a better option for you than the other.
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- Reviewed By Thomas Brock, CFA®, CPA
- Published: March 10, 2023
- Updated: June 30, 2023
- 9 min read time
- This page features 8 Cited Research Articles
- Edited By
- A CD is a deposit to a bank, credit union or brokerage firm while a bond is a loan made to a corporation or government entity.
- Most CDs pay you back interest when they reach maturity, while most bonds give you staggered, regular payments, called coupons.
- If interest rates are high, some CDs may yield better returns than short duration bonds.
- When interest rates are low, bonds are likely to yield better returns than CDs.
- A CD typically has term lengths of three months to five years, and bonds have common term lengths of one year to 30 years.
How CDs and Bonds Compare
CDs and bonds are low-risk investment options that have maturity dates, fixed interest rates and can be laddered to increase your savings. A CD is a deposit to a bank, credit union or brokerage firm. A bond, on the other hand, is a loan made to a corporation or government.
While CDs and bonds have similarities and are considered safe, they have different pros and cons to consider. Learning how CDs and bonds compare can help you determine which you want to invest in, if not both. Diversifying your portfolio with multiple streams of income, like with a CD or bond, can be beneficial to a retirement plan.
|Factors to Consider||CD||Bond|
|How they’re issued||CDs can have different types of issuers. Such as:
Only brokered CDs can be issued by a broker.
|Varies depending on the type of bond.
|Common term lengths||Three months to five years||One year to 30 years|
|Return rates||Varies depending on the maturity of your CD.
For a 12-month CD, the average annual return rate is 1.66%.
|Varies depending on your type of bond.
The current yield on a 10-year U.S. Treasury bond is around 4.00%.
|Potential penalties||If you access your funds before the CD’s maturity date, you will face a penalty.
The penalty will require you to pay the issuer a portion of your interest earnings.
|If you sell your bond before it matures, you could risk losing part of the principal.|
|When to expect your interest||Once your CD matures, with your initial deposit back.||In staggered payments until your bond matures.|
|Safety of investment||CDs from a bank or credit union are typically insured for up to $250,000, so they are considered a very safe investment.
Note that some brokered CDs are not insured. Always confirm that your CD will be insured before you buy it.
|Treasury bonds are the safest types of bonds since they are backed by the full faith and credit of the U.S. government.
Corporate bonds aren’t as safe of an investment since you could lose your money if the company goes bankrupt.
Before investing in bonds, especially, longer duration bonds, be sure to understand the concept of interest rate risk. Essentially, bond prices are inversely related to interest rates. In a rising rate environment, bonds experience downward price pressure, which can result in negative investment returns. Conversely, in a falling rate environment, bonds experience upward price pressure, which can boost returns.
Issuers and Terms
No matter where your CD is issued from — a bank, credit union or brokerage firm — the terms are generally the same. You agree to a set amount to be deposited, with a fixed interest rate and maturity date. The term length is typically three months to five years.
You cannot add to your initial deposit amount once the CD is finalized unless you have an add-on CD.
A bond can be issued by the government and corporations, with maturity terms ranging from one to 30 years. Like a CD, bonds have a set deposit amount with a fixed interest rate and maturity date.
Interest and Return Rates
You typically get the highest interest rate with corporate bonds since they present the most risk. Interest rates for CDs and government-issued bonds are similar since they both present little to no risk. However, as interest rates fluctuate, this projection could change.
- You typically receive your interest with your principal investment after your CD matures.
- Bonds are considered fixed-income investments since your interest is paid back to you in staggered payments throughout your bond’s term. These payments are called coupons. Your coupon payment schedule is determined by your issuer.
Your return rates vary depending on the type of CD or bond you have. For a 12-month CD, the average annual return rate is 1.36%, according to the FDIC, whereas the average yield on a 10-year U.S. Treasury bond is currently hovering around 4.00%.
Penalties and Risks
If you withdraw money from your CD before it reaches maturity, you will face an early withdrawal penalty. This penalty is typically taken out of your earned interest.
You also face inflation risk with long-term CDs. If inflation rates spike and you have a five-year CD, your money will no longer be keeping up with inflation.
“The biggest risk for a CD is that you could get less than what inflation and taxes take away, which is purchase power risk,” Barbara O’Neill, CFP®, CEO of Money Talk and author of Flipping a Switch, told RetireGuide.
With bonds, you face the risk of losing part of your principal, according to an article from the American Association of Individual Investors. If you need to liquidate your bond before it matures, and its bond price has fallen, you will lose a part of the principal and future interest payments.
The biggest risk for a CD is that you could get less than what inflation and taxes take away, which is purchase power risk.
While CDs and government bonds are both considered safe, there is some risk with a corporate bond.
Generally, your CD is always insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC) or National Credit Union Administration (NCUA).
A bond, on the other hand, is not insured by the FDIC or NCUA.
If your bond is issued by the government, it is backed by the full faith and credit of the U.S. government. This means that 100% of your initial deposit and interest is guaranteed back to you, without a limit.
A corporate bond is not backed by the full faith and credit of the U.S. government. So, your investment would be in danger if the company who issued your bond went bankrupt. You should check the company’s credit rating before buying a bond. Three common credit rating agencies are S&P Global, Moody’s Investors and Fitch Ratings.
Liquidity is the investment vehicle’s ability to convert assets to cash without affecting its worth. Since both bonds and CDs have maturity dates, they don’t have much liquidity when compared to other investment options, like a high-yield savings account.
However, when comparing the two, CDs have more liquidity than bonds. This is because CDs have shorter term lengths compared to a bond. If you have a three-month CD, it will be easier to liquidate and quicker than a one-year bond.
Which One Is Right for You?
There are three factors to consider when determining if a CD or bond fits your needs — how much risk you want to take, the current interest rates and your financial goal.
With a bond, you face the risk of losing part of your principal. If you need to sell your bond before its maturity date and the bond’s price has dropped, you will lose a part of your principal and future interest.
“If you’re looking for the safety of your principal, you should consider a CD. However, there may be some bonds you might want to look into. For example, the Series I bonds or TIPS are federal government bonds with negligible risk of loss,” O’Neill told RetireGuide.
The current interest rates will determine whether a CD or bond will be right for you. If the interest rates are high, some CDs are likely to yield a better return than some short duration bonds, according to an article from CETO Intelligent Banking Solutions.
On the other hand, when interest rates are low, bonds generally offer higher returns.
If your goal is to retain an additional long-term steady stream of income, a bond would be a better fit for you. If you’d prefer to have a short-term investment with a lump-sum at the maturity date — it would be better to consider a CD.
|When To Consider a CD||When to Consider a Bond|
This isn’t to say you can only consider a CD or a bond — you could get both. They’re generally safe investment options to consider as you near retirement. Before getting both a CD and bond, it would be in your best interest to meet with a financial advisor to determine your needs.
If you’re looking for the safety of your principal, you should consider a CD. However, there may be some bonds you might want to look into. For example, the Series I bonds or TIPS are federal government bonds with negligible risk of loss.
CDs vs. Bonds FAQ
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8 Cited Research Articles
- Hartford Funds. (2023, January 25). What’s the Real Return on 12-Month CDs? Retrieved from https://www.hartfordfunds.com/practice-management/client-conversations/investing-for-income/real-return-on-12-month-cds.html
- Bank of America. (2023). Understanding Bonds and Their Risks. Retrieved from https://www.merrilledge.com/article/understanding-bonds-and-their-risks
- U.S. Bank. (2022, October 18). What Are the Fees and Penalties for Early Withdrawal on a CD? Retrieved from https://www.usbank.com/customer-service/knowledge-base/KB0206677.html
- Federal Deposit Insurance Corporation. (2021, December 8). Deposit Insurance FAQs. Retrieved from https://www.fdic.gov/resources/deposit-insurance/faq/
- National Credit Union Administration. (2020, March). Deposits Are Safe in Federally Insured Credit Unions. Retrieved from https://ncua.gov/newsroom/press-release/2020/deposits-are-safe-federally-insured-credit-unions
- American Association of Individual Investors. (2001, November). You Can Lose With Bonds. Retrieved from https://www.aaii.com/journal/article/you-can-lose-with-bonds
- PIMCO. (n.d.). How Do Rates Affect Bond Performance? Retrieved from https://web.archive.org/web/20230307110732/https://global.pimco.com/en-gbl/marketintelligence/navigating-interest-rates/how-do-rates-affect-bond-performance
- Adams, T. (n.d.). Certificates of Deposit in a Rising Rate Environment. Retrieved from https://www.ceto.com/blog/cds-in-a-rising-rate-environment