If you’re worried about losing your money in the stock market, you’re not alone. A recent study conducted by TransUnion revealed that 75% of Americans expect the economy to drift into a recession by the end of 2023. That concern has inspired many people to look for safe places to park their money to avoid the potential for a major downturn -- certificates of deposit and bonds being two of the lowest-risk investments available. But is one better than the other? That, of course, all depends on your investing goals.
As you look ahead to the rest of the year and work to protect your cash, now is the time to understand the differences between CDs and bonds.
What is a CD and how does it work?
A certificate of deposit -- simply known as a CD -- is a type of traditional savings account that pays a fixed interest rate of return for a set period of time. Banks offer CDs typically with terms that range from as short as three months to as long as five years, although there are some terms available that are shorter and longer. If you’re browsing credit unions, you won’t see the name “CD” but rather “share certificate.” Don’t be confused -- they’re the same product, the difference is that CDs are offered at banks, which are for-profit financial institutions, whereas share certificates are available at not-for-profit credit unions.
The big difference between a CD and a savings account is access. With a savings account, you can withdraw your money anytime, but with a CD, you need to leave your money in the account until the maturity date of the CD’s term, unless you’re willing to pay an early withdrawal penalty.
Here’s a rundown of the common terms you should understand that will be attached to CDs:
Term: This is the length of time you’ll need to lock your money away in a CD or share certificate. Banks and credit unions typically pay you a higher interest rate than you’d find on other savings products because you’re agreeing to leave your money untouched for the full term.
Minimum deposit: Some banks and credit unions have minimum deposit requirements to qualify for their best interest rates, while others will let you open a new account with as little as $1.
Interest rate: CD interest rates vary from bank to bank. Generally, you’ll find the highest APY -- that’s the annual percentage yield, which includes the total earnings based on your interest rate and the compounding frequency -- at online financial institutions with lower overhead costs. It’s critical to shop around and compare interest rates. For example, while the Federal Deposit Insurance Corporation lists average interest rates for 12-month CDs as 1.72% in mid-July, banks such as Synchrony, Capital One and Ally were all paying 4.80% or more APY.
Insurance: CDs typically are protected by FDIC insurance, while share certificates are covered by insurance from the National Credit Union Administration. Both types of protection will keep up to $250,000 safe per depositor, per insured financial institution, per account ownership category (single, joint, retirement accounts). That means that if the institution fails -- as recently exemplified by the First Republic Bank failure -- your money is safe.
Early withdrawal penalty: If you’re in a situation where you need your money prior to maturity, you’ll pay a penalty for the access. It’s common, for example, to see most banks charge 90 days’ worth of interest on CDs with a maturity of less than one year.
Other types of CDs
The most common type of CD is one that includes a set rate and a penalty if you need the money early. However, there are quite a few different CD products that might fit your needs:
No-penalty CDs: These will waive the worry of paying any penalty if you need the money earlier than expected, but they pay a lower rate, too.
Add-on CDs: While traditional CDs require your full deposit upfront, these let you make more deposits after your initial opening.
Bump-up and Step-up CDs: If you believe interest rates will go up in the next year or two, bump-up CDs can give you the peace of mind to take advantage of those higher rates. You get to make a one-time request to boost your rate with these. However, if rates don’t rise prior to maturity, you’ll never get to take advantage of the option.
Step-up CDs earn APYs that increase incrementally according to a predefined schedule within the term. So, for example, a bank offers a 24-month step-up CD in which the APY increases by 0.20% every six months, ranging from 0.05% to 0.65% for a blended APY of 0.35%. Although not a high-yielding CD, a step-up CD is a favorable option if the blended rate is competitive when compared with lower-yielding traditional CDs. One benefit a step-up offers is no early withdrawal penalties.
What is a bond and how does it work?
Bonds are basically loans: You buy a bond from a corporation or a government, and the bond’s issuer uses your money to help fund its operations and growth strategy. In the process, you’ll earn interest on the bond, and your investment is generally very safe. The worst-case scenario for the bondholders is when the corporation declares bankruptcy or the government falls into default.
You can buy Treasury bonds, savings bonds and corporate bonds via a range of channels. Savings bonds issued by the federal government -- I bonds and EE bonds -- are typically purchased online at TreasuryDirect.gov, while it’s customary to buy corporate bonds via an investment account at a brokerage firm. It’s also common to buy bond funds, which include a wide range of bonds, rather than just one company or government.
Here’s a rundown of some of the standard terms to know when it comes to investing in bonds:
Term: Bonds typically come with terms that range from one to 30 years.
Minimum deposit: I bonds -- issued by the federal government -- can be purchased with as little as $25. Other types of bonds may have larger minimum purchase requirements. Vanguard, for example, sells most bonds in increments of $1,000, while municipal bonds are sold in $5,000 chunks. However, you can buy into bond mutual funds and exchange-traded funds, which often carry no minimum purchase amount.
Yield: Your yield is simply how much you will earn from the bond. However, bond investing isn’t as simple as, say, investing in a CD. The axiom for bonds is that, when interest rates rise, bond prices fall and vice-versa. If bond rates rise after you purchase the bond, your bond is, effectively, worth less than what you purchased it for. On the flip side, if bond rates go down, your bond is worth more.
This inverse relationship is important to understand because you can sell your bond before it reaches maturity (people do this all the time). Depending on when you sell, the value will likely be different than when you purchased the bond. Bonds made a lot of news earlier this year when Silicon Valley Bank had to sell a huge chunk of bonds at a loss, which played a major role in the bank’s eventual failure.
Risk: Bonds are fairly safe bets because you’re highly likely to get your principal investment back. Government bonds issued by the federal government are generally perceived to be one of the safest bets available, while corporate and municipal bonds carry a greater risk.
CDs vs. bonds
CDs and bonds can both be great additions to your portfolio, but there are nuances to consider with each of them.
| CDs | Bonds | |
| Who offers them | Banks and credit unions | Federal government, municipal governments and corporations |
| Interest rate | Fixed | Fixed at the date of purchase, but move up and down -- and will impact your earnings if sold before maturity |
| Term | 3 months to 5 years (some shorter and longer terms are available) | 1 to 30 years |
| Minimum Deposit | Varies from bank to bank, but some have $0 minimum deposit requirements | $25 for I bonds; many bond funds have no minimum purchase requirement |
| Additional deposits allowed | No -- unless it’s an add-on CD, which are rare | Yes |
| Risk | Early withdrawal penalty may apply | Potential loss if the issuer declares bankruptcy or goes into default -- plus the potential for a drop in value in a rising-rate environment |
| Access to funds | Not until maturity (unless you pay an early withdrawal penalty or open a no-penalty CD) | Most can be sold on the secondary market at any time; I bonds bought directly from the government have a 1-year minimum cash-in period |
When is a CD better than a bond?
A CD can be a great option if you know exactly how much money you need and when you’ll need it. For example, if you’re planning to buy a house in a little over a year, a 12-month CD can be a solid pick. If you deposit $20,000 in a CD that pays 5.00% APY, you’ll have another $1,000 at the maturity date. That may be enough to cover a chunk of your closing costs. Plus, the CD’s early withdrawal penalty can eliminate the temptation to spend any of your money.
When is a bond better than a CD?
Bonds are a good option if the clouds of a recession seem to be gathering. According to analysis from Fidelity, bonds have delivered higher returns than the stock market and cash (CDs) in every recession period since 1950. However, you need to be comfortable with the potential for swings in value as interest rates rise and fall.
Is now a good time to buy bonds or CDs?
Casey T. Smith, president of Georgia-based Wiser Wealth Management, says that now is a good time for certain CDs. “CDs are looking good right now, but the highest yielding ones are more short-term,” Smith says. “This is because if a deep recession were to happen, everyone expects interest rates to fall.”
On the bond side, it depends on the type of bond. A midyear analysis from Charles Schwab points to the potential for declines in high-yield corporate bonds if the economy slows down.
How do you buy CDs and bonds?
There’s nothing that says you can’t have both. Actually, it can be a smart move to diversify your portfolio with bonds, CDs and stocks. How much you allocate between the three depends on your financial goals and investing timeline. Regardless of your goals and allocations, opening a CD or buying a bond is fairly simple.
How to open a CD
You can open a CD at most banks and a share certificate at most credit unions. Before you do, compare options for minimum deposit requirements and APYs so you can estimate your total return. If you open a CD at an online bank, you’ll need to be prepared to transfer your deposit from another account. You can also open a CD at a physical bank branch. Either way, you’ll need to share some basic details with the financial institution including your Social Security number, address and other personal information.
How to buy bonds
The easiest way to buy bonds is via an investment brokerage account. While you can buy individual bonds from certain corporations or governments, it’s complicated and can be pricey. It’s typically better to invest in bond mutual funds that spread your investment across a wide range of similar bonds -- all with the same investment grade, for example. These typically have lower minimum investment amounts, and they ’re easier for amateur investors to navigate than attempting to buy bonds on the secondary market (which involves commission fees).
If you want to buy bonds issued by the federal government, you can create an account at TreasuryDirect.gov.
Other savings products to consider
CDs and bonds can both be good additions to your investment portfolio, but there are plenty of other low-risk savings products that are paying competitive rates right now, too.
Money market accounts
A money market account is a cross between a standard savings account and a checking account. Unlike CDs and bonds, you won’t need to worry about paying an early withdrawal penalty or trying to sell it on a secondary market if you need the money. You can always access it. Plus, there are some banks and credit unions that are paying great rates for money market accounts right now. However, some institutions require very large deposit requirements to qualify for the best money market account rates.
High-yield savings accounts
So far in 2023, high-yield savings accounts look true to their title as some of the top-yielding accounts are paying between 4% and 5% APY, which are comparable with CDs and bonds. In fact, Smith points out that these can be a much better option than dealing with government-issued bonds.
“The I Bond yield is currently 4.30%,” Smith says. “Considering there’s some paperwork to get the investment started, I would rather just shop for a high-yield savings account. Many are yielding 4.50% to 5.00% APY with a lot less hassle and have the same government backing with no holding period restrictions.”
FAQs
Not necessarily. Bonds have bigger risks than CDs due to interest rate sensitivity. However, they’re both relatively low-risk investments. For example, bonds can provide a good balance to more volatile investments such as stocks.
One reason to buy a CD over a bond is if you’re looking for a very short-term investment. CDs are available in three-, six- and nine-month term lengths, which can give you a very predictable return for a need in the near future. While you can cash in bonds at any time, some of them carry penalties. I bonds, for example, require you to forfeit the last three months of interest if you cash them in before the five-year mark.
No. Both CDs and bonds are fairly low-risk investments, but CDs are a bit safer due to the protection of insurance coverage from federally insured banks and credit unions that are members of the FDIC and NCUA, respectively. Certain types of bonds, on the other hand, carry the potential risk of losing your principal if the corporation or municipality that issued the bond faces serious financial troubles.