Bonds vs CDs: What's Smart for Your Money?

The money you put away to save for your goals can be invested in several ways. Many investors work on building a strong stock portfolio because they like the potential for faster growth. But focusing on stocks can mean worrying more about market volatility — something some savers can’t or don’t want to deal with.

Instead, more conservative investors may be drawn to tools that have a reputation for offering returns with a lower risk, such as bonds and certificates of deposit (CDs). The growth is typically slower and less risky with these saving strategies.

But even aggressive investors may find a place for CDs or bonds in their financial plan, depending on their goals and time horizon to reach those goals. So, knowing the ins and outs of CDs and bonds can be beneficial regardless of what type of investor you are.

What Are CDs and Bonds?

A certificate of deposit (CD) is a financial product where a customer deposits a set amount of money for a fixed period of time with a financial institution that pays interest on the deposit. In other words, an investor deposits a set amount of money in a bank, credit union, or other financial institution and agrees to keep it there — without touching it — for a designated length of time (anywhere from a few months to a few years).

When that time is up, the investor gets back the money deposited plus any interest earned. CDs tend to pay higher interest rates than regular savings and checking accounts. But because investors must keep their money in the CD account until it reaches maturity, they aren’t as liquid as savings or checking accounts. Moreover, most CDs have an early withdrawal penalty.

A bond is a loan from an investor to a company or government entity, which then uses the capital raised from the loan to finance long-term projects or investments. With bonds, investors agree to tie up their money in exchange for a set number of interest payments over a predetermined period of time.

The principal is repaid when the bond reaches its maturity date, or an investor may choose to sell the bond before it comes due — particularly if the market value increases.

Why Might an Investor Want a CD?

CDs are a popular option for savers when interest rates are high because they offer attractive rates with less risk than other investment options. Unlike most investment options, CDs are FDIC-insured for up to $250,000 per depositor. And having money in a CD can add some diversification to an investor’s overall asset allocation.

Retirees who have transitioned their focus from capital accumulation to preservation may keep some of their funds in CDs because of the lower risk than stocks or other assets. But CDs can also be useful for younger savers looking for a place to safely stash money for a down payment on a house or for college savings.

Because of the early withdrawal penalty, traditional CDs may not be considered a liquid asset like other go-to savings tools, like a savings or checking account.

CD savers willing to pay the penalty can get their money if needed without worrying about selling stocks, bonds, or other assets in their portfolio (which could mean a loss if the market is down).

Recommended: How to Invest in CDs: A Beginner’s Guide

Popular Types of CDs

There are CDs with shorter terms — three months, six months, or one year — and even no-penalty CDs, so finding a CD that aligns with a saver’s goals is relatively feasible. Some CDs also allow the account holder the opportunity to go beyond the basics, including:

•   Bump-up CDs: If the bank offers new CDs at a higher interest rate, a bump-up CD gives the account holder the option of requesting the higher rate (usually once per term).

•   Step-up CDs: Rates are also adjusted with a step-up CD, but the issuer sets the level and number of raises, not the account holder.

•   Add-on CDs: Most CDs start and end with one deposit. With an add-on CD, you can make additional deposits throughout the life of the CD. Some issuers don’t limit the number of additional deposits, and some do.

•   Jumbo CDs: A jumbo CD requires a larger deposit — typically a minimum of $100,000. In return, this type of CD typically pays a higher interest rate.

Risk-averse savers who can find terms that suit their needs might want to consider keeping some money in CDs if the market’s unpredictability makes them too nervous. And undisciplined spenders might find the hands-off restrictiveness of a CD makes it easier to save than a traditional savings or checking account.

What Are the Benefits of Bonds?

Bonds aren’t quite as safe as CDs but are typically considered a lower-risk investment than stocks. Most bond values usually don’t fluctuate as much as stock prices, so fretful investors may feel less anxious about what’s happening to their money day to day.

One of the big benefits of bonds is that they can provide a reliable income stream. Because bonds usually pay a fixed amount of interest twice a year, investors can make plans based on those payments and reinvest the money or use it to pay their bills.

Popular Types of Investment Bonds

There are many different kinds of bonds, and each has benefits and drawbacks depending on the investor’s needs. The four main categories are:

•   Corporate bonds: These bonds are issued by corporations to raise money for expansion, special projects, research, and other business-related costs. Corporate bonds typically offer higher interest rates than the other types of bonds, but the interest is taxable on both the federal and state level.

•   Municipal bonds: Often called munis, these bonds are issued by states and local government entities to pay for public services or projects. Investors might be helping to build a city park, better roads, or a new football stadium, for example. Those who like the idea of investing in a way that fits with their personal values might find munis appealing. The interest rate is generally lower than corporate bonds that may be similarly rated, but the interest received is exempt from federal taxes.

•   Treasury bonds: T-bonds are U.S. government debt securities. They pay interest semi-annually until maturity (between 10 and 30 years). Income from the interest on these bonds is exempt from state and local taxes, but it is subject to federal income tax. Treasury bonds don’t typically pay as well as corporate bonds, but because the federal government backs them, they’re considered a very safe investment.

•   High-yield bonds: High-yield bonds are bonds that pay higher interest rates because they have lower credit ratings and are more likely to default than other bonds.

Like CDs, bonds are often attractive to older investors who may want to shift their portfolio mix to a lower percentage of stocks and a higher percentage of low-risk, fixed-income investments. But younger investors may find that keeping even a small position in bonds — particularly U.S. Treasuries — can serve as a hedge against stock market volatility.

Disadvantage of CDs and Bonds

Right now, one of the biggest downsides to owning CDs is the limited return, which can leave a long-term investor vulnerable to inflation risk. Slowly losing money to inflation isn’t as dramatic as a big stock market drop.

But savers who lock themselves into multi-year CDs, thinking that’s a way to get a better interest rate, may find those CDs are actually costing them money. The longer savers invest in CDs instead of more aggressive options, the more potential growth they could lose out on.

And, of course, there’s always that early withdrawal penalty to think about. The penalty amount can vary depending on the CD’s term and the financial institution that issues it. The penalty will be waived if the account holder dies, and possibly if that person becomes disabled or unemployed, but it’s up to the issuer to make those decisions.

Like CDs, bonds are relatively long-term investments, which makes them vulnerable to interest rate risk. Interest rates have an inverse relationship with bond prices. So, for example, if investors buy a 10-year bond paying 4% interest, and a couple of months later the issuer offers bonds at 5% interest, the market price of the older bond will decrease to compensate. Investors who decide to sell those older bonds could take a hit on the price, while investors who stick with the bond may have to accept that they’re earning less than the optimum interest.

And though bonds may earn more interest than a savings account or a CD, historically, they just don’t provide investors with the same kind of growth as they get with stocks.

For example, the average stock market return is 10% per year, while long-term government bonds have returned between 5% and 6% annually. Investors who are counting on bonds to get them to their goals can expect a safer but slower jog to the finish line.

Finally, though bonds are considered safer than stocks, they aren’t completely free of risk. If an issuer defaults on its obligations, investors could lose out on interest payments, getting back their principal, or both.

Defaults are far more common with corporate bonds than municipal bonds, but it isn’t unheard of for governments to default on their debts. Investors can protect themselves by doing some research on the financial health of the issuer and looking for bonds with high credit ratings. This is especially important if a bond has a far-off maturity date.

How Do I Open a CD Account?

A good first step in opening a CD is for the investor to think about what best suits their needs (a longer or shorter term, a larger or smaller deposit, fixed or variable rate, etc.). Then, using those parameters, they would shop for the best rates, which can be found on various financial institutions’ websites or on sites that compare current rates.

Probably the easiest way to open a CD is to do it online. But if the investor prefers to use a local financial institution, it can be done in person. A CD can be funded with cash, a check, or by transferring money from another account. And some investors may choose to open a CD within their existing individual retirement account (IRA).

Some CDs may come with costs, such as monthly maintenance fees, or a purchase fee if the investor goes through a broker.

How Do I Purchase a Bond?

Buying bonds can be more complicated than opening a CD.

U.S. Treasury bonds, notes, bills, savings bonds, and inflation-protected securities (known as TIPS) can be purchased through TreasuryDirect.gov , which is sponsored by the U.S. Department of the Treasury’s Bureau of the Fiscal Service. Or they may be purchased through a bank, broker, or bond dealer.

Municipal and corporate bonds are traded over the counter, which means they must be purchased through a dealer, bank, or brokerage firm, either individually or in a mutual fund or exchange-traded fund (ETF). (Some municipal bonds may be available directly through the municipality.)

Investors can usually search bonds by rating, maturity, type of issuer, and other features. But investors who have questions or concerns about pricing, transaction fees, minimums, or the uncertainty of bond ratings from year to year may wish to work with a financial advisor to get assistance choosing and buying bonds.

The “Laddering” Approach of Bonds and CDs

Investors also may want to talk to their banker, broker, or advisor about using a CD or bond “ladder.”

Laddering is a strategy in which an investor holds several bonds or CDs with different maturity dates to minimize interest-rate risk, increase liquidity, and diversify credit risk. Laddering can take some of the stress out of trying to predict what will happen to interest rates over time.

Recommended: Your Ultimate Guide to Certificate of Deposit Ladders (CD Ladders)

Finding the Right Fit: CDs vs Bonds, or Both?

As with any investment tool or strategy, it can be useful to look at how using CDs or bonds fits with the big picture — the saver’s overall financial plan — but also to consider how these tools might help with reaching specific goals.

CDs may be an appropriate choice for someone saving for a short-term goal, such as an expensive vacation, a wedding, or a down payment on a home. CDs also may be a solid, stress-free savings tool for those who are extremely risk averse. And they can help diversify a portfolio and protect savings in a market downturn.

But, as with any low-risk investment, a CD isn’t going to grow that money very quickly.

Bonds, which carry a little more risk but also more potential for growth, are a popular choice for those looking to protect their assets from big stock market fluctuations.

Financial professionals generally advise investors to base their mix of stocks and bonds on their tolerance for risk and their timeline — the number of years they have until they expect to reach retirement or some other financial goal.

One often-cited, long-held rule of thumb for saving for retirement, the “rule of 100,” states that investors should hold a percentage of equities equal to 100 minus their age. So, for example, a 30-year-old might have 70% of their portfolio in stocks and the rest in safer assets, including high-grade bonds and CDs.

However, some advisors are now suggesting investors who have a longer life expectancy might want to bump that number to 110 or even 120, to ensure their money lasts as long as they do.

The decision will be different for each individual — and because it’s a big one, it may be worth considering getting a little help.

The Takeaway

The decision to invest in bonds or CDs is ultimately a personal one. Both investments have advantages and disadvantages, so it’s important to consider your financial situation to make the best decision about where to put your money. Research each type of investment thoroughly and take the time to understand the risks and rewards associated with each of them. With the right information and careful consideration, you can make the decision that’s best for your financial future.

Whether for a short-term goal or something more long-term, like saving for retirement, investing requires careful evaluation of several factors — and the options can be overwhelming. But SoFi can help. With a SoFi Invest® online brokerage account, you can trade stocks, ETFs, fractional shares, and more with no commissions. Plus, you can access educational resources and financial market updates through the SoFi app.

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