CDs vs. Bonds

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.

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.

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.

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%.

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.

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.

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.

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.