Bonds vs. CDs: What’s the Difference?

Navigating the investment landscape can be overwhelming, even when it comes to fixed-income securities like bonds and CDs. While both aim to offer conservative growth, they differ in risk and returns.

This article will break down the essential differences, empowering you to choose the option that best suits your financial strategy.

Bonds vs. CDs: Key differences

	Bonds	CDs
Issuer	Issued by governments, municipalities or corporations.	Issued by banks and credit unions.
Risk level	Riskier, with the potential for issuer default, especially for corporate and high-yield bonds.	Low-risk, typically insured by FDIC up to $250,000 per depositor.
Interest rate	Can have fixed or variable rates, usually higher than CDs, due to increased risk.	Can have fixed or variable rates, but fixed-rate CDs are most common.
Maturity	Maturity periods can range from months to 30 years or more.	Usually have shorter terms, ranging from months to five years.
Market trading	Can be traded on secondary markets before maturity, leading to price fluctuations.	Cannot be traded; must be held until maturity or withdrawn early with penalties.
Principal	Principal is at risk if sold before maturity at a lower price or if the issuer defaults.	Principal is safe, and full amount is returned at maturity, assuming no early withdrawal.
Insurance	Not insured by the FDIC or other agencies.	Typically insured by the FDIC up to $250,000 per depositor per bank.
Interest payments	Typically pay periodic interest.	Interest may be paid at maturity or periodically, depending on the terms.

What is a bond?

A bond is a debt security through which you lend money to an issuer, such as a government, corporation or other entity.⁽¹⁾ In return, the issuer promises to pay you interest at regular intervals, known as coupon payments, and to return the full amount of your loan when the bond reaches its maturity date. The full amount of your loan is known as the bond’s face value.

Organizations commonly use bonds to raise funds for projects or operations and are generally considered more stable than stocks. Because they provide regular interest payments, bonds are classified as fixed-income securities.

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Pros

• Steady income. Bonds offer investors regular interest payments, which offers a reliable source of income throughout the life of the bond.
• Low volatility. Bonds generally have low volatility, especially when they are issued by entities with strong credit ratings, such as governments or highly rated corporations. Their prices tend to be stable due to the fixed interest payments and the promise of returning the principal at maturity.
• Preserves capital. At maturity, the bond issuer typically repays the full principal to the bondholder, ensuring the initial investment is returned. This feature makes bonds a valuable choice for investors seeking long-term capital protection and peace of mind, though default risk should still be considered.

Cons

• Bond prices can fall if interest rates rise. The relationship between interest rates and bond prices is inverse. As rates increase, the market value of existing bonds typically declines.⁽²⁾ This drop can lead to capital losses for investors.
• Bond issuers may default. Some bond issuers may fail to meet their obligations, resulting in unpaid interest or unreturned principal to bondholders. This potential for default, particularly with corporate bonds, introduces an additional layer of risk that investors need to consider.⁽³⁾
• Call risk. Some bonds are callable, meaning the bond issuer has the right to buy them back before they reach maturity. Callable bonds can limit the investor’s potential returns if the bonds are called when interest rates decline, as they may miss out on future interest payments.

What is a CD?

A certificate of deposit (CD) is a type of savings account that holds a fixed amount of money for a set period, known as the term, which can range anywhere from three months to 10 years.⁽⁴⁾

In exchange for leaving your money untouched during the term, the bank or credit union usually pays a fixed interest rate, which is typically higher than that of a regular savings account. At the maturity date — when the term ends — you can withdraw your money and the interest earned.

While fixed-rate CDs are most common, some CDs offer variable rates that fluctuate over time.

CDs are considered a low-risk, stable way to grow your savings, though you typically can’t access your money early without paying a penalty.

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Pros

• Guaranteed returns with a fixed interest rate. Most CDs offer a stable and predictable growth rate, allowing investors to plan their finances with confidence. The fixed interest rate means that no matter how the market fluctuates, your returns remain unaffected until the maturity date.
• Safe and low-risk investment, especially at federally insured banks. Investing in CDs is considered low risk since they are often backed by the Federal Deposit Insurance Corporation (FDIC), which insures deposits up to $250,000. This protection provides peace of mind, knowing your money is safe as long as you stay within the insured limits, even if the bank faces financial difficulties.
• Higher interest rates compared to regular savings accounts. CDs typically offer better interest rates than standard savings accounts, making them an attractive option for conservative investors looking to earn more on their deposits. This higher yield allows you to grow your savings more effectively, especially over longer terms.

Cons

• Inflation can beat your returns. One significant drawback of CDs is that if inflation rates exceed your fixed interest rate, the purchasing power of your returns may decline over time. While your money may grow nominally, it could buy less in the future, reducing the overall benefit of your investment.
• May incur early withdrawal penalties. If you need to access your funds before the CD matures, you may face early withdrawal penalties that can significantly diminish your earnings. This restriction can limit your financial flexibility and make CDs less appealing if you require immediate access to their savings.
• Potentially lower returns than other investment options like stocks or bonds. While CDs provide security, they typically offer lower returns than riskier investments such as stocks or bonds. Investors willing to accept higher risk may miss out on greater growth opportunities that could better meet their long-term financial goals

Bonds or CDs: Which is right for you?

Choosing between bonds and CDs depends on your financial priorities and how you prefer to manage your money.

Bonds may offer regular income and the potential for higher returns, but they come with more risk and price fluctuations. Fixed-rate CDs, however, provide guaranteed returns with a fixed interest rate, minimal risk and no price fluctuations, though your money is typically locked away for a set period.

If you’re ready to explore investment options, check out the best brokerage accounts to find the right platform for your financial goals.

Frequently asked questions

Can minors own bonds?

Yes, minors can own bonds, specifically Series I and Series EE bonds, through TreasuryDirect.⁽⁵⁾ However, an adult must purchase these bonds, either as a gift or on behalf of the minor.

Do you pay taxes on CDs and bonds?

Interest earned on CDs is considered taxable income by the IRS. Interest on bonds is taxed depending on the issuer: interest from corporate bonds is taxable at the federal level and may be subject to state and local taxes. Interest from municipal bonds is usually exempt from federal taxes and sometimes from state taxes if issued in your state. US Treasury bond interest is subject to federal taxes but exempt from state and local taxes.⁽⁶⁾