CDs vs. Bonds: What’s the Difference?

What Is a CD?

A CD is an account you can use to save money at a bank or credit union for a set period, or term, which can range from one month to 10 years. At the end of the term, the CD matures, and you can either withdraw the initial deposit (plus interest) or roll the balance over into a new CD.

CDs often offer a higher annual percentage yield (APY) than traditional savings accounts. As of June 20, 2023, a 12-month CD’s average APY was 1.63%, while a standard savings account earned just 0.42% interest, according to the Federal Deposit Insurance Corp. (FDIC). You can also find high-yield CDs with APYs over 4%.

The tradeoff for higher earnings with a CD is limited access to your money during its term. If you withdraw money from your CD before it matures, you’ll pay an early withdrawal penalty, usually a certain number of months of earned interest.

Pros and Cons of CDs

To decide if a CD makes sense for you, consider the positives and negatives.

Pros of CDs

• May be federally insured: CDs held in a bank insured by the FDIC or a credit union insured by the National Credit Union Administration (NCUA) are federally insured for up to $250,000 per financial institution and per account holder.
• Low-risk investment: Federally insured CDs are lower risk ways to grow your money than investing with stocks and bonds. CDs can help to diversify your financial portfolio and protect your purchasing power against the effects of inflation.
• Guaranteed returns: CDs typically have fixed interest rates. Assuming you don’t withdraw your money from a fixed-rate CD before it matures, you’ll know exactly how much money you can expect to earn at the end of its term

Cons of CDs

• Penalties for early withdrawal: If you need to withdraw money from your CD for any reason, you’ll forfeit some of your earned interest as a penalty. This is a contrast to traditional savings accounts that allow you to withdraw money at any time without losing earned interest.
• Relatively low rate of return: Although CDs offer a guaranteed rate of return, other investment options, such as stocks, could earn more.
• May require a minimum deposit: You can often open a standard savings account with little to no money. Although no-minimum CDs do exist, many banks and credit unions require a minimum deposit for CDs, typically starting at around $500.
• Limits access to your money: A CD isn’t the ideal place to put money you may need quickly, such as your emergency fund. CDs are better used for short-term savings goals, such as saving up for a vacation, a wedding or a down payment on a home.

What Is a Bond?

Bonds are loans made to governments and businesses to finance construction and other projects. When you buy a bond, you’re essentially acting as a lender to the bond issuer for a set time frame or term, typically one to 30 years. Throughout the term, the bond issuer pays you interest, usually twice a year. At the end of the term, the bond matures, and you get back its face value or par value (the amount you paid for it).

The three primary types of bonds are:

1. Treasury bonds, issued by the federal government, which include Series I or Series EE savings bonds
2. Municipal bonds, issued by municipalities
3. Corporate bonds, issued by businesses

The par value of a bond typically starts at $1,000, although you can find them as low as $100, and Series I and Series EE bonds can be purchased in increments as small as $25. You can buy bonds from a broker or, in some cases, from the government institution issuing them. For example, you can buy Series I and EE bonds online at TreasuryDirect.gov.

Once you buy a bond, you can sell or trade it just like stocks (one exception is savings bonds). However, you’ll lose any interest you would have accrued had you held the bond to maturity, and if the bond’s par value has dropped since you bought it, you won’t recoup your initial investment.

Pros and Cons of Bonds

Like CDs, bonds have their upsides and downsides.

Pros of Bonds

• Generate regular income: Bonds pay predictable, regular income, which can be especially helpful in retirement. Many people shift their investment portfolio more heavily to bonds as retirement gets closer.
• Low-risk investment: While it’s not unheard of for municipalities and companies to default on a bond, it’s typically rare. Treasury bonds are backed by the full faith and credit of the federal government. In general, bonds are considered a very safe investment.
• Diversify your investment portfolio: Even if most of your investments are riskier ones, such as stocks, adding bonds to your asset allocation mix can help cushion you against market ups and downs.
• Potential tax benefits: Treasury bonds aren’t subject to state taxes. Municipal bonds are generally not subject to federal taxes; some municipal bonds are free of state taxes, too.

Cons of Bonds

• Relatively low rate of return: Investments such as stocks and real estate generally provide higher rates of return than bonds.
• Not without risk: Even though bonds are one of the safest investments, there is still an element of risk. In general, corporate bonds are riskier than government bonds. Fitch Group, Moody’s and S&P Global Ratings rate bond issuers based on the risk of default; the higher the rating, the lower the risk.
• May require large initial investment: Although some bonds are relatively affordable, others require investments of $5,000 or more.
• Restricts your access to funds: Getting your money out of a bond before maturity requires selling it. If the bond’s face value has dropped since you purchased it, you’ll lose money on the sale—not to mention losing future interest income.

When to Choose a CD vs. a Bond

When does it make sense to use a CD, and when should you choose a bond?

Buy CDs when:

• Interest rates are high. You’ll lock in high interest rates until the CD matures.
• You want a shorter-term savings vehicle. While bonds generally mature in one to 30 years, CDs are available in shorter increments.
• You want the security of FDIC or NCUA insurance. Bonds are not federally insured.
• You want a simpler savings option. Bonds can be complex. If you’re taking the DIY approach to saving and investing, a CD may be easier to choose on your own.

Buy bonds when:

• Inte rest rates are high. As interest rates rise, bond prices drop.
• You want ongoing income. Regular interest payments from a bond can supplement your income or be reinvested.
• You want tax benefits. Bonds that are free from federal or state income taxes provide a tax shelter.
• You want to diversify your investments. Bonds can balance out stocks to reduce risk in your financial portfolio.

The Bottom Line

Both CDs and bonds are relatively low-risk ways to save money and earn interest, but if you want access to your savings quickly, they may not be the best choice. High-yield savings accounts can offer APYs equal to CDs or bonds, while letting you withdraw your money without penalties.

No matter how you choose to save money, building an emergency fund is key to good financial health, as is a good credit score. Consider setting up free credit monitoring from Experian to keep tabs on your credit and get alerts of important changes.