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Bonds and certificates of deposit are generally safe ways to earn returns on your savings, but they play different roles in your financial life. Here’s what to know.
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1. To lock up savings for short-term goals. If you’re setting aside money to buy something like a car or a house in the next few years, a CD can be a solid, hands-off approach. As a guard against tapping into that money, CDs have early withdrawal penalties; for example, you could lose three to six months’ worth of interest. (If you'd rather keep adding funds to an account instead of locking up savings at a fixed rate, check out our list of .)
2. To get guaranteed returns without much risk. CDs — or share certificates, as credit unions call them — have federal insurance for up to $250,000 per account. So, if the bank or credit union went bankrupt, you would still get your money back. Plus, a CD’s rate of return is fixed, which makes CDs appealing for people who want to shield some of their income from the fluctuations of the stock or bond market, for instance, after taking distributions from a pension or retirement account.
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1. To cushion against stock market volatility. Odds are, if you have a retirement account such as a 401(k) or IRA, you already have money in bonds. If retirement is some 30 years away, you might choose to invest your retirement account more heavily in stocks than in bonds, since you have time to weather stock market fluctuations and benefit from stocks’ typically higher average annual return. Once you’re closer to retirement, you might choose to weight your investments more toward bonds, since the more bonds you have, the steadier your return generally becomes.
For long-term goals such as retirement, “bonds can help provide a smoother ride for investors in bumpy markets,” says Derek Brainard, director of financial education at the AccessLex Institute, a nonprofit that offers financial literacy resources to law students.
2. To generate steady income over time. Bonds are considered a “fixed-income investment” because the bondholder — that’s you — receives interest payments generally in regular installments, such as every six months. And when bonds are held to maturity, you’ll also get back the full amount you put in.
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However, as Seattle certified financial planner Dana Twight explains, it’s hard to compare individual bonds to see if you’re getting a good deal. The value of bonds changes often, and rates of return vary by the duration and type of bond. Plus, depending on the bond, there might be risk of a company going bankrupt.
Apart from U.S. Treasury bonds, you normally would buy individual bonds only if you had enough money to build a diversified bond portfolio, and that generally requires a significant sum of six figures or more.
» Want to know more? Here’s a guide on