Investing in CDs and bonds can provide modest returns with no risk for some categories and less risk than the stock market for others, depending on what types of these investments you buy.
You can invest in the stock market, but it’s not the only place. Certificates of deposit (CDs) and bonds are other ways your money can work for you, such as generating passive income. CDs are a risk-free way to earn interest. In their various forms, bonds function as an investment that is generally less risky than the stock market. In this article, Benzinga compares CDs vs. bonds to help you discover which is better for you.
Read more to learn how these lower-risk investment options appeal to risk-averse individuals by offering a relatively low level of risk.
CDs vs. Bonds: Overview
CDs vs. bonds vary in several aspects. The most important is how they differ in the risk to your principal, or the initial amount you invest. With a CD or Treasury bonds — unless the U.S. were to experience a catastrophic bank failure — you will surely get the amount of money back you paid to buy them. For corporate/municipal bonds and bond funds, you accept the risk of losing your principal in the event of bankruptcy or market fluctuations.
What are CDs and bonds, and how can they boost your investment portfolio?
CDs
A CD is a secure, low-risk savings option that can be beneficial for several reasons. When you open a CD, you agree to leave your money deposited for a fixed period, ranging from a few months to several years. In exchange, the bank or credit union typically offers a higher interest rate than a regular savings account, allowing your money to grow at a guaranteed rate.
Pros of a CD
Higher interest rates than traditional savings accounts
Unlikely to lose your principal
Low-to-no risk investment backed by Federal Deposit Insurance Corporation (FDIC) insurance
Fixed interest rate provides predictable returns
Short-term and long-term options available
Allows you to lock in a rate for a specific timeframe
Encourages disciplined saving as there are penalties for early withdrawal
Cons of a CD
Limited liquidity and access to funds before maturity
Early withdrawal penalties
Lower returns compared to other investments like stocks or bonds
Interest rates may be lower than inflation, resulting in a loss of purchasing power
The opportunity cost of tying up funds for the CD's term length
Rates are subject to change upon renewal of the CD
Bonds — Corporate/Municipal Bonds, Bond Funds and Treasuries
Bonds aren’t as straightforward as CDs. When you purchase a bond, you lend money to a government, municipality or corporation in exchange for regular interest payments over a set period. At the end of the bond's term, assuming the entity issuing the bond doesn’t default or go bankrupt, you receive the principal investment back. People close to retirement or seeking a reliable source of passive income may like getting the predictable stream of income a corporate or municipal bond can provide.
The tricky thing about the general term bonds is that they encompass several types of bonds, including corporate, municipal, bond funds, and U.S. government Treasury bonds. Of these four types, you can lose your principal if you invest in corporate or municipal bonds or bond funds.
Pros of Individual Bonds
Provide a steady stream of income through regular interest payments
Generally less volatile than stocks
Can help diversify an investment portfolio
Principal investment is returned at maturity (for individual bonds)
Some bonds are tax-exempt at the federal, state or local level
Pros of Bond Funds
Offer instant diversification across many different bonds
More liquid than individual bonds
Professionally managed
Can reinvest interest payments to compound returns
Pros of U.S. Treasury Bonds
Easy to buy at TreasuryDirect
There is no risk of losing your principal except for the unlikely event of U.S. government failure
Cons of Individual Bonds
Risk of default (credit risk) if the bond issuer cannot make payments
Susceptible to interest rate risk (prices fall when rates rise)
May not keep pace with inflation over time
Callable bonds can be redeemed early by the issuer
Cons of Bond Funds
There is no guarantee that you’ll recover your principal if you sell at any given time, especially in a rising interest rate environment
Subject to management fees that can eat into returns
NAV (share price) fluctuates with the underlying bond prices
Tax inefficient because interest income is taxable annually
Cons of Treasury Bonds
Generally pay lower rates than other types of savings
CDs vs. Bonds: Which is Right for You?
There is no definitive answer to whether CDs or bonds are right for you — your choice depends on your investment goals and risk tolerance level.
When to Consider CDs
CDs can be a good choice to generate passive income from money you won’t need in the near future. CDs can work if you:
Don't need immediate access to and want to earn higher returns than a traditional savings account
Are looking for reliability and safety
Seek the safety of insurance Insured by the FDIC for up to $250,000 per depositor per institution
Want a predictable stream of income with fixed interest rates
Desire a low-risk way to grow your savings without the volatility of the stock market
When to Consider Bonds
The various types of bonds can be a good choice for your investment portfolio. Bonds can work if you:
Desire a more stable source of income and relatively low risk compared to stocks
Hope to receive your principal investment back at the end of the investment period
Are nearing retirement or seeking a reliable source of passive income
Want less volatility than the stock market
Are aiming for a hedge against stock market downturns
Seek investment diversification
Individual bonds and bond funds present investment risk. The U.S. Securities and Exchange Commission (SEC) explains, “A common misconception among some investors is that bonds and bond funds have little or no risk. Like any investment, bond funds are subject to investment risks including credit risk, interest rate risk and prepayment risk.”
CDs vs. Bonds: Compare at a Glance
This table illustrates some of the differences among these investments.
| CDs | Corporate and Municipal Bonds | U.S. Treasury Bonds | Bond Funds |
Where to Buy | Online or brick-and-mortar bank or credit union | Brokerage | Brokerage | |
Issuer | Banks and credit unions | Public and private companies; state governments | U.S. government | Brokerage: investment company |
Duration | Three months to 5 years | One to 30 years | One to 30 years | Indefinite until you sell |
Typical Rate of Return | Varies, but up to 5% in 2024 | Varies, but generally 4% to 5% in 2024 | Varies, but generally 4% to 5% in 2024 | Varies, but expected rate is 4% to 5% |
Payout | Interest is paid at the end of the term | Paid periodically until maturity | Interest is paid at the end of the term | If any profit is generated, realized when you sell |
Risk | None unless banks and credit unions fail | Risk of default | None unless the U.S. government fails | Market risk |
Diversification is an Investor’s Best Friend — CDs and Bonds Are Worth Your Acquaintance
Five years ago, few investment professionals recommended CDs or U.S. Treasury bonds because interest rates were so low. In 2024, you can earn upward of 5% interest on these financial offerings with no risk. You lock up your money for a period of time, but you get a guaranteed safe return. Corporate and municipal bonds and bond funds are other ways to diversify your financial portfolio. As you solidify your financial goals and nail down your personal risk tolerance, you can figure out which is better for you.
First published by Benzinga.
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