Contributor, Benzinga
December 2, 2022

Understanding the key differences between bonds and certificates of deposit (CDs) can help you make better investment decisions. CDs and bonds offer opportunities for portfolio diversification while providing relative stability. While CDs are considered a type of deposit account, bonds can be viewed as a type of loan. The two investment options appeal to risk-averse individuals by offering a relatively low level of risk. Investing in CDs and bonds can offer investors peace of mind by providing modest and relatively dependable returns. 

What Are CDs?

CDs are often viewed as a financial tool used to save money. CDs are considered a type of savings account that provides higher interest rates than those offered by typical savings accounts. A CD offers higher interest rates in exchange for individuals willingly locking away their funds for an agreed-upon amount of time. CD terms last from three months to several years. The term length indicates the amount of time that an individual will not be able to access their funds. At the end of the CD term, customers will be able to access their funds in addition to the provided interest. 

Financial institutions such as banks and credit unions offer CDs. A key benefit of CDs is that they have a certain level of predictability while offering account holders higher interest rates than the ones provided by other more-flexible savings accounts. 

In terms of safety, CDs remain a strong investment option. The CDs created at Federal Deposit Insurance Corporation (FDIC)-insured banks are insured. This feature helps improve trust between the public and financial institutions. 

CDs appeal to more risk-averse individuals by offering predictable returns and security. However, CD rates are generally low, even during times of inflation.

What Are Bonds?

Bonds are a type of loan made by governments and corporations to raise funds. Bonds are designed to be repaid with interest to investors. 

Government bonds are bonds that are offered to investors by national governments to raise money. These bonds are often considered the safest and most predictable. 

State and lower local governments offer municipal or muni bonds.

Corporations provide corporate bonds to investors. Investors that hold a corporate bond to maturity typically receive their principal in addition to interest. However, corporate bond investors are often exposed to an increased level of uncertainty because of the possibility of defaults. A default occurs when a borrower does not make the necessary payments and ultimately defaults on the bond. 

Because bonds can bolster a portfolio against risk, they can be viewed as a slower and less aggressive investment opportunity. Bonds take time to reach maturity, at which time the bond’s principal is fully repaid to an investor. The amount of time that it takes a bond to reach maturity depends on the specified terms. For example, short-term bonds usually take about one year to be repaid. In contrast, long-term bonds could require about a decade to reach maturity. 

Bonds are considered less volatile than stocks but still expose an investor to a certain level of risk. The issuer of a corporate bond may default, exposing an investor to financial loss. Recall that bonds remain susceptible to inflation, meaning that increases in inflation can decrease the value of a bond.

Benefits of Investing in CDs

CDs have several benefits such as flexible timelines, improved returns, increased predictability and greater security. A CD has safeguards in place that can provide investors with peace of mind. 

Flexible timelines: Investors can select a timeline that works best with their investment goals. For example, CD terms tend to range from a few short months to over a decade. This flexible timeline helps investors achieve financial goals and meet liquidity needs. Shorter-term CDs provide more flexibility but pay lower interest rates.

Predictability: CDs offer fixed interest rates. A set or fixed interest rate indicates that the rate does not change throughout the duration of a CD. 

Security: For a risk-averse investor, CDs can hold a certain appeal because of their safety. CDs purchased from an FDIC-insured bank enjoy the benefit of being protected. According to the FDIC, deposits adhering to the rules and regulations are protected at FDIC-insured institutions for $250,000. Before investing, research specific financial institutions to understand the rules and regulations. 

Improved returns: CDs with longer-term lengths typically have higher rates. The elevated interest rates are intended to incentivize potential investors into locking away their funds for an extended period. 

Benefits of Investing in Bonds

Bonds help offset aggressive investments and diversify a portfolio. The benefits of bonds include predictability, stability and the ability to safeguard capital. 

Predictability: Depending on the type, investments can often be unpredictable or volatile. Bonds are perceived as a predictable alternative to investments such as stocks. Bonds typically provide interest every six months, and the amount of interest varies depending on the bond.

Stability: Bonds are viewed as stable because they are loans that have clear terms and conditions. Bonds can reduce the amount of risk that an investor is exposed to within a more aggressive portfolio. 

Safeguard capital: Bonds repay an investor their principal in addition to interest. Bonds help protect the initial capital investment by stipulating that an investor must be repaid according to the indicated terms. Although bonds assist in safeguarding capital, borrowers may default. 

Possible tax benefits: Bondholders receive certain tax perks such as tax exemptions. For example, investors in U.S. Treasury bonds benefit from state tax exemptions. U.S. Treasury bonds are typically subject to federal taxes. Research the potential tax benefits associated with government-issued bonds to understand which option would likely work best for your financial situation. 

Special Considerations for Bond and CD Investing

Prior to investing in bonds and CDs, consider the risk of inflation, potentially low returns and a decrease in liquidity. 

Risk of inflation: Inflation may increase interest rates, which decreases the value of CDs. 

Low returns: Bonds and CDs offer lower returns compared to other investment options such as stocks. However, stocks expose investors to an elevated level of risk. While bonds and CDs offer lower returns, they tend to provide a level of stability that’s unattainable for more aggressive investment options. 

Decreased liquidity: Investors must understand that bonds are tied to a maturity date, which makes them relatively illiquid compared to cash. Avoid placing funds into a CD or bond that you need to keep easily accessible. Instead, create an emergency fund to quickly access cash when you need it. An emergency fund should typically cover a minimum of three months of expenses.

Time: For time-sensitive investors, long-term CDs and bonds can prove unattractive. Long-term CDs usually take more than one year to reach maturity. In contrast, long-term bonds often take over a decade to reach maturity. Both bonds and CDs are considered long-term investments depending on the term lengths. 

Compare Bond Brokers

Benzinga offers useful insights and reviews about CDs and bonds. Before investing, contemplate speaking with a financial professional to understand what would work best for you. 

Frequently Asked Questions

Q

Are bonds better than CDs?

A

Bonds and CDs can prove beneficial depending on main considerations such as current and future interest rates. The two are often viewed as safer investments. Ultimately the preference between bonds and CDs depends on personal preference. 

Q

Are CDs the same as bonds?

A

Although CDs and bonds are often viewed as smart options for moderate to low growth, they are not the same. CDs and bonds respond differently to interest rates and follow distinct structures. For example, CDs are categorized as a type of deposit account while bonds are typically considered a loan. Overall, bonds and CDs should not be considered the same.