Certificate of deposits (CDs) vs. bonds: How do they compare? (2024)

If you’re looking for a secure investment with decent returns, both certificates of deposit (CDs) and bonds may be worthy of consideration.

CDs are an excellent place to park your cash and earn interest on your balance. Although there’s a risk of inflation outpacing CD interest rates, they are virtually guaranteed earnings.

Bonds, on the other hand, may deliver higher returns and regular income via interest payments. While bonds can offer more liquidity, there’s a risk of default from the issuer and values fluctuate inversely to interest rates because when interest rates increase, new bonds are issued with the higher rate which makes existing bonds less attractive.

Here’s a closer inspection of the difference between CDs vs. bonds so you can get a better idea of which investment option is right for you.

Overview of CDs

A certificate of deposit is an account you deposit money into and can’t touch for a set amount of time. During that period, your money earns interest on its balance.

If you access the money before the time period ends, referred to as maturity of the account, you will likely pay penalties. Once the maturity date arrives, you can withdraw your money or roll it into a new CD.

CDs don’t allow much flexibility because you generally can’t access the money without penalty during the term. However, there is a common strategy called CD laddering, which helps create liquidity with certificates of deposits. With a CD ladder, you buy multiple CDs with varying durations, so they have a consistent schedule of accounts maturing at different times.

Pros and cons of CDs

There are many pros and cons of using a CD to grow your savings. Here are some benefits:

• Interest rates: CDs often offer higher rates than other savings options. For example, the national average interest rate for savings accounts is 0.45%, while the average for a 12-month CD is 1.76% (as of September 2023).
• Safety: Most banks and credit unions are insured by the FDIC or NCUA, meaning your CDs are safe up to $250,000. They are considered low-risk investments.
• Reliable: Returns on CDs are virtually guaranteed. You can usually approximate how much money you will have by the end of the CD’s term.

While there are many benefits to CDs, they also have some drawbacks, including:

• Limited accessibility: After depositing your money in a CD, you typically cannot access the funds without penalty until maturity.
• Penalties: If you need to take money out of the CD early, you’ll likely have to return some of the interest you have earned.
• Inflation: CD interest rates may not outpace inflation, lowering your money’s purchasing power. You can reduce this risk by investing in shorter-term CDs.
• Lower returns: Although CDs are lower risk, you may see smaller returns than you would with stocks or mutual funds.

Overview of bonds

A bond is essentially an IOU. The issuer, often a corporation or government, issues bonds for investors to purchase.

To entice investors to purchase the bonds, the issuer promises to pay interest until the bond matures and the principal returns to the investor.

Businesses often use the money raised from the bonds to buy property, refinance debts, sustain operations or hire more employees. Governments may use it to improve infrastructure, fix roads or fund schools.

There are many different types of bonds and term durations. They typically have a fixed interest rate paid semiannually (every six months).

Pros and cons of bonds

Bonds are a relatively safe way to earn regular investment income and diversify your portfolio. Here are some benefits:

• Fixed income: One of the best aspects of bonds is that you receive regular income from interest payments, usually every six months.
• Potential profit: You may be able to resell bonds for a premium on the secondary market.
• Safety: Bonds are generally considered safe investments. They tend to be less volatile than stocks. Bond investors can recover some of their money if the company goes bankrupt because they will have a claim on the company’s assets and cash flows, though the bond’s terms determine the priority of the claim.

Although there are upsides to investing in bonds, there are also some downsides:

• Lower returns than stocks: Stocks have a higher risk, but you may also see greater returns with stocks than bonds.
• Interest rate risk: If the Fed raises interest rates higher than your bond’s interest rate, its market value will fall.
• Risk of default: There’s a risk of the issuer defaulting on the bond. Some bonds, like high-yield bonds, are more risky but offer higher interest rates. However, there are safer options, like bonds from the government and reputable corporations, for risk-averse investors.

When to consider CDs

CDs may be an appealing option if you’re looking for a safe investment with guaranteed rates and you don’t expect to need early access to your funds. If interest rates are high, you may want to lock in those returns by investing in a CD.

But locking in rates also means locking up your cash. Withdrawing your money early will typically come with a penalty. If an emergency arises and you have to cash out the CD early, you’ll likely lose some of the interest you’ve accrued.

This lack of liquidity is why it’s essential to establish an emergency fund before opening a CD. You could also open a liquid CD (typically with a lower interest rate) to avoid penalties if you withdraw early.

However, if you’re confident you won’t need the funds until maturity, a CD may offer a better rate than other types of savings accounts.

When to consider bonds

Bonds are attractive investments because they pay interest in regular installments. The fixed interest payments make them an excellent option for those seeking a predictable passive income source.

Like CDs, bonds are ideal if you won’t need the money before maturity. To access your funds early, you would have to sell the bond on the secondary market. Although you may be able to sell for a profit, a bond can also lose value. However, you won’t need to worry about the secondary market value if you plan to hold the bond to maturity.

While there’s a chance that the issuer could default, bonds are still considered relatively safe investments. Even if the issuer goes bankrupt, bondholders often have some claim to its assets and cash flow.

Diversifying your portfolio with CDs and bonds

“Certificates of deposits and bonds are commonly regarded as conservative investment options,” said Hazel Secco, CFP, CDFA, president and founder of Align Financial Solutions, a financial advisory company.

“CDs … are considered highly secure due to their protection of the principal investment. However, it’s worth noting that CDs may not be the ideal choice for long-term investments, as they expose investors to interest rate risk upon maturity.”

If inflation rates outpace your CD’s interest rates during its term, your money may have less purchasing power at maturity than when you deposited it.

“On the other hand,” explained Secco, “bonds can … fluctuate based on prevailing interest rates, as they share an inverse relationship.”

When interest rates increase, the value of bonds with fixed rates falls, according to the SEC.

“Nevertheless, bonds can play a pivotal role in diversified portfolios designed for long-term investment objectives,” said Secco. “Their dependable income, generated through coupon payments, can be particularly beneficial for income-focused portfolios during wealth distribution phases.”

Investors should ideally diversify their portfolios with both CDs and bonds to reduce risk and maximize returns.

What to consider when choosing CDs or bonds

There are a few factors to contemplate when selecting CDs vs. bonds:

Investment timeline

Start by considering how long you want your money to stay invested.

CD terms range anywhere from one month to five years, or longer. They may be better short-term investments due to a lack of liquidity and inflation risk.

Bonds are considered longer-term investments. They can extend anywhere from one to 30 years.

Risk tolerance

You should also consider your risk tolerance. While both CDs and bonds are generally safe investments, both carry their own risk factors.

CDs face inflation risk, while bonds face interest rate risk. Investing in a mixture of both can help hedge your investments.

You may see greater returns with high-yield bonds if you’re more risk-tolerant. These bonds are from less financially stable businesses, so they pay higher interest rates.

Financial goals

“It’s essential to have a clear understanding of your financial goals before deciding which of these investment vehicles aligns best with your needs,” said Secco.

Bonds offer a fixed, predictable income from interest. They are also more liquid and may see greater returns than CDs.

However, if you’re looking for a highly secure and easy way to earn interest, CDs may be more suitable to your goals.

Which is right for you?

After weighing your timeline, tolerance to risk and goals, you’ll likely know whether CDs or bonds are right for you.

CDs are usually best for investors looking for a safe, shorter-term investment. Bonds are typically longer, higher-risk investments that deliver greater returns and a predictable income.

Bonds are also more liquid than CDs because you can buy or sell them on the secondary market—although some bonds may be harder to sell than others. They may also require a larger investment since bonds are often issued in $1,000 increments.

Ideally, you would invest in both CDs and bonds to diversify your portfolio. It may help maximize your returns and distribute risk among your investments.