CDs vs. Bonds: Which Fixed-Income Investment is Right for You?

When it comes to growing your money, understanding the different types of investment options available to you is crucial. Certificates of deposit (CDs) and bonds are two popular choices that offer predictable returns, but they come with distinct features, benefits, and risks.

CDs offered by banks and credit unions provide a fixed interest rate and are insured by the FDIC, making them a low-risk option for conservative investors. Bonds, on the other hand, represent a loan to corporations or governments that can offer higher yields along with tax benefits, though they come with varying levels of risk.

Key takeaways

• Both CDs and bonds help you grow your money by earning interest.
• Maturity dates matter so that you can get the most out of your investment in bonds or CDs and avoid penalties.
• Bonds have potentially higher yields but also higher risk.
• CDs are federally insured.

CDs vs. bonds

	CDs	Bonds
Where to obtain	Banks or credit unions	Banks, credit unions, brokerage firms, and the U.S. Treasury
Initial investment required	Generally $500+	Varies
Risk level	Low	Varies
Payout date	At maturity	Periodic interest payments and principal payout at maturity
Penalties	For early withdrawal	Possible losses if sold before maturity or if the issuer defaults
Terms	Fixed terms from 3 months to 5 years or more	Varies from a few months to 10 years or more
Insured	Yes, up to $250,000 by the FDIC	No, except U.S. Treasury bonds that are backed by the government

CDs and bonds both serve as fixed-income investments but come with different features and risks. You could open a CD through your bank or credit union for a relatively low initial investment. While they may not earn as much as a bond, they are less risky and are insured by the FDIC or NCUA.

On the other hand, bonds could provide you with a steady income through regular interest payments that are often tax exempt. However, bonds do have more risks, due to inflation, interest rate fluctuations, and the possibility of default by the issuer.

Which should you choose?

The choice between CDs and bonds really depends on your financial goals and preferences. CDs may be ideal for conservative investors seeking stable, insured returns, whereas bonds offer more varied investment options with potentially higher returns. However, bonds also come with increased risk.

Interest rates are an important factor when deciding between CDs and bonds. For example, it’s wise to take advantage of a CD’s fixed interest when interest rates are high because you can lock in a high rate for several years. On the other hand, high interest rates aren’t advantageous for bonds, which may lose their value as newer bonds are issued at higher rates.

Whether you choose a CD or a bond, it is important that you hold onto either investment until its maturity date. Otherwise, it could cost you. With CDs, you’ll incur penalties for early withdrawals. With bonds, you could lose part of your principal investment as well as future interest payments.

Who should choose a CD?

You should choose a CD over a bond if you are a conservative investor seeking a stable, predictable income stream without much risk. CDs may be ideal investments for retirees or those nearing retirement. The fact that CDs are insured by the FDIC or NCUA provides an extra level of security for your money and ensures that your initial investment is protected.

Who should choose a bond?

If you’re willing to take on some level of risk for potentially higher returns, you should choose bonds over CDs. Bonds often offer higher yields than CDs, and their periodic interest payments could provide a steady flow of income. Bonds are also better for those with a longer investment horizon and who can tolerate the potential market fluctuations. The tax benefits of bonds may also be attractive, especially if you are in a higher income tax bracket.

What is a CD, and how does it work?

A certificate of deposit, or CD, is a financial product similar to a savings account, which could help you earn money through interest. CDs are usually offered by the best banks and credit unions, and they typically earn higher interest rates than traditional savings accounts. However, the trade-off is that if your money is in a CD, you can’t access it for a fixed period. If you do, you could be subject to penalties, which could reduce the overall interest you earn.

CD maturity terms range from about 3 months to 5 years or more. The longer you commit to leaving your money in a CD, the higher interest you’ll earn. At the end of the term, the CD matures, and you receive your original deposit plus any accrued interest.

Similar to other banking products, CDs are insured by the Federal Deposit Insurance Corporation (FDIC) up to the maximum allowed by law, making them a secure investment option.

Types of CDs

There are several types of CDs, which cater to different financial needs and goals. These CD types differ in the interest rates they earn, the deposit amount required, and the possible penalties for early withdrawal. The common types of CD accounts include:

• Traditional CDs: Traditional CDs are what you will usually find offered at your bank or credit union. They have fixed interest rates and terms ranging from a few months to several years. They also charge penalties for early withdrawals.
• Jumbo CDs: Jumbo CDs require large minimum deposits, usually of $100,000 or more. They also often earn higher interest rates.
• No-penalty CDs: A no-penalty CD is just what it sounds like. These CDs allow for withdrawals without penalties before the term ends. However, they also usually offer lower interest rates than traditional CDs.
• Bump-up CDs: With a bump-up CD, you have the option to increase, or “bump up,” the interest rate to a higher rate once during the fixed term of the CD. This could be useful if interest rates are expected to increase.
• Step-up CDs: Similar to the bump-up CD, but with a step-up CD, the interest rate increases at regular intervals throughout the term of the CD rather than just once.
• High-yield CDs: High-yield CDs provide a higher interest rate than standard CDs, much like a high-yield savings account.
• Add-on CDs: With these CDs, you can make additional deposits during the CD term.
• Callable CDs: The financial institution that issued the CD can “call” or redeem it before its maturity date. Callable CDs usually offer higher interest rates to compensate for the risk that the bank may redeem the CD early. If the CD is called, you would receive your initial deposit and any interest earned up to the call date.

CD features

CDs have several key features that distinguish them from other types of savings and investment products, such as:

• Fixed terms: When you deposit funds in a CD, you usually can’t access those funds during a specified term, which could be 3 months to 5 years or more.
• Fixed interest rate: During the specified CD term, your money accrues a fixed interest rate, payable when the CD matures. This rate is usually higher than you would get on a normal savings account.
• Minimum deposit: Most financial institutions require a minimum deposit to open a CD, which could range from about $500 to $2,500 or more. Banks that require higher minimum deposits typically offer higher interest rates. Once you’ve opened a CD, you can’t deposit more funds into the account during the CD’s term.
• Interest payments: Many CDs pay out interest earned when they mature. However, there are CDs available that may provide interest payments monthly, quarterly, or annually.
• FDIC/NCUA insurance: Like other bank accounts, CDs are usually insured by the FDIC up to $250,000. CDs from credit unions are insured by the National Credit Union Administration (NCUA).
• Early withdrawal penalties: With most CDs, you could incur a penalty if you withdraw funds before maturity. The penalty may involve forfeiting some or all of the interest you’ve earned.
• Maturity date: The maturity date on a CD is the fixed date when you can withdraw your money without penalty.

Where to open an account

You can likely open a CD at your local bank or credit union. Credit unions may offer higher interest rates, but you are usually required to be a member to take advantage of those rates. Membership may be restricted to people who work in certain industries, for specific employers, or are involved in certain organizations.

Online banks such as Ally Bank and Discover Bank may also offer CDs at rates that are competitive or higher than those at traditional banks.

Pros and cons of CDs

What is a bond, and how does it work?

A bond is a fixed-income security that represents a loan made by an investor to a borrower. As the investor, when you buy bonds, you are, in essence, lending money to the issuer of the bond, which is typically a corporation or government. Corporations and government agencies issue bonds when they need to raise money. For example, a city may issue bonds to upgrade its public transportation systems. Or, a company may issue bonds to build a new manufacturing facility and expand its operations.

Types of bonds

There are several types of bonds you could invest in:

1. Government bonds are issued by the federal government. For example, Series I savings bonds are government bonds issued by the U.S. Department of Treasury.
2. Municipal bonds are issued by states, cities, and other local government entities.
3. Agency bonds are issued by government agencies.
4. Corporate bonds are issued by companies and corporations.

Bond features

Here are some key features of bonds to be aware of:

• Face or principal value: The principal, or face value, of a bond is the amount of money that you initially invest in it. Bonds are typically issued in denominations of $1,000. When the bond reaches maturity, you get the face value back.
• Coupon rate: A bond's coupon rate is the interest rate you earn as the bondholder. This rate is usually a percentage of the bond's face value and is usually fixed. Interest payments may be made monthly, quarterly, semiannually, or annually. For example, a bond with a face value of $1,000 and a coupon rate of 5% will pay $50 annually.
• Maturity date: A bond’s maturity date is when the principal is repaid to you, the bondholder. Bonds can have short–term maturity dates within a few months up to 4 years, intermediate-term maturities between 5 and 10 years, or long-term maturities of 10 or more years.
• Yield: A bond's yield is the return you can expect to earn annually if you hold it until maturity. It includes the principal value of the bond plus the interest earned over the time you’ve held it. The yield can be influenced by the bond’s purchase price, coupon rate, and time to maturity, as well as the market.
• Credit ratings: Bond issuers receive credit ratings based on their creditworthiness. Bonds issued by entities with low credit ratings are considered a higher credit risk.
• Taxes: With bonds, the interest you earn may be exempt from federal and state income taxes, depending on the type of bonds you invest in. For example, U.S. Treasury bonds are taxable at the federal level but are exempt from state and local taxes. Municipal bonds issued by state and local governments are usually exempt from federal income tax. Corporate bonds are generally subject to federal, state, and local taxes.

Potential bond risks

There aren’t penalties associated with bonds, like with CDs, and they are generally considered a safer investment than stocks. However, investing in bonds does come with some risk. Here are a few disadvantages to investing in bonds:

• Interest rate fluctuations: Interest rate changes may affect a bond's market value. When interest rates rise, bond prices typically fall, and vice versa.
• Credit risk: This is also called default risk because it’s when the bond issuer cannot make the required interest payments or repay the principal at maturity. A bond’s credit rating indicates whether it is a high or low credit risk.
• Inflation risk: An increase in inflation may erode the purchasing power of a bond’s interest payments and principal. If the inflation rate exceeds the bond’s interest rate, the value of the bond can be almost negative.
• Liquidity risk: This risk occurs when a bond is difficult to sell without significantly lowering its price or value.
• Call risk: There is a chance that the bond issuer will redeem or " call” the bond before its maturity date, leading to lower overall returns. Issuers may call a bond if interest rates decline.

Where to buy a bond

You can buy bonds from a variety of sources that each offer different types of bonds. For example, you can buy government savings bonds directly from the U.S. Department of Treasury at the TreasuryDirect website.

Banks, credit unions, and brokerage firms offer a wide range of bond options, including corporate, municipal, and government bonds. You could also purchase a portfolio of bonds through mutual funds or exchange-traded funds (ETFs).

Pros and cons of bonds

Alternatives to bonds and CDs

If you are still on the fence about investing in bonds or CDs, there are other alternatives available to help you grow your money. Here are a few options:

High-yield saving accounts

With high-yield savings accounts, you could earn interest rates that are competitive with CDs while still having the ability to access your funds without penalty. Personally, accessibility is the main reason I have my money in a high-yield account instead of a CD. For example, the interest on my high-yield account with American Express is 3.80% (as of December 17, 2024).

Money market accounts

Money market accounts earn interest at a higher rate than traditional savings accounts. Unlike CDs, you can withdraw money from your money market account without penalties. Money market accounts differ from high-yield savings accounts in that they sometimes offer tiered interest rates, which could help you earn more with larger deposits.

Dividend-paying stocks

If you are looking to invest in corporations but want a higher return on your investment than bonds may offer, you may want to consider dividend-paying stocks. These stocks are shares in companies that regularly distribute a portion of their profits to shareholders as dividends. Dividend payments are made quarterly, annually, or semi-annually. These stocks can be more volatile but offer higher potential returns through dividend income and capital gains.

FAQs

Bottom line

Both CDs and bonds offer distinct advantages and are suited to different types of investors. CDs provide a low-risk, insured investment with fixed interest rates and predictable returns, making them ideal for those seeking stability and security. On the other hand, bonds could offer higher yields and tax benefits but come with increased risks, such as interest rate fluctuations and credit risk.

When deciding between the two, consider your financial goals, risk tolerance, and investment horizon. CDs might be the right choice if you prefer guaranteed returns and minimal risk. However, bonds could be a better fit if you’re open to taking on some risk for potentially higher returns. Consulting a financial advisor could help you determine the best strategy for your needs, so you can build a portfolio that balances stability and growth.