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.
First, what are CDs? And what are bonds?
- A CD is a type of savings account in which you agree to lock up some of your money at a bank or credit union for a set period, typically three months to five years. At the end of the period, the CD matures and you get back your money plus interest earned. You tend to earn more interest in a CD than a regular savings account. There’s usually a minimum amount you need to deposit, which varies by bank.
» Learn more about how CDs work
- A bond is a loan to a company or the government. As with a CD, you tie up your money for a fixed term in exchange for interest at a fixed rate, but unlike a CD, a bond can be sold before it matures. Bonds generally require minimum investments, which often range from $100 to $5,000 or more depending on the type of bond, and can be issued in increments. While it’s possible to buy individual bonds, many people choose to purchase them through bond mutual funds, which offer lower-cost access to a diversified group of bonds. (For more, see our explainer on bonds.)
When to open a CD
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.
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.
» If you’re ready to save with CDs, it’s important to compare rates across different banks to get the best return. Here’s a look at three top options:
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When to consider bonds
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, regional manager 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.
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 how to buy bonds
Compare at a glance
|Issuer||Bank or credit union.*||Varies by type of bond, such as:
|Terms||3 months to 5 years||1 year to 30 years|
|Rate of return||Best CD rates are 2%-3% APY||Currently 2%-3% for Treasury bonds; varies for other bonds and bond mutual funds (e.g., a fund’s goal might be to match bond market performance or focus on a narrow set of bonds).|
|When do I typically receive interest?||Once the CD matures. This lets you take advantage of compound interest. (See what you could earn with our CD calculator.) |
Depending on the bank, you could receive regular interest payments instead.
|In regular installments until a bond matures.|
|Penalty for accessing funds?||Yes, early withdrawal penalty tends to be 3 to 6 months' worth of interest, or more.|
(Learn about the exception: no-penalty CDs.)
|Potential risk in losing value if you're selling bonds instead of waiting for them to mature.|
|Money protected?||Yes, CDs have federal insurance of up to $250,000 per customer at an insured bank (see more on FDIC insurance).||Varies by type of bond.
|*Brokerages can provide CDs as well, but only brokered CDs, which differ in some regards from standard CDs.|