CDs vs. Bonds: What's the Better Investment Now?

The sheer number of investments available at any given time can often feel overwhelming, but two of the most popular are CDs and bonds. The big question is this: Which is a better investment for you right now? The answer depends on your risk tolerance and investment goals.

Here's a quick breakdown of both designed to help you decide your next best investment move.

CDs

CDs, or certificates of deposit, are a type of savings account readily available through banks and credit unions. CDs typically offer a fixed rate of interest for a set period of time, ranging anywhere from three months to 10 years. Because CDs are FDIC-insured, you know your investment is protected up to $250,000 if your financial institution fails.

Advantages of opening a new CD

• Your money is guaranteed to be safe if you invest less than $250,000 in a single CD.
• Today's CD rates are impressively competitive.
• As long as you don't withdraw the money from your CD before it matures, you know precisely how much you're going to earn on the investment.
• Some CDs require no minimum deposit, meaning you can open one with a very small investment.
• Technically, you can put as much into a CD as you want (although it's never wise to put more than $250,000 in a single CD).

Disadvantages of opening a new CD

• It's possible to lose a portion of your principal investment if you withdraw from your CD before the term is up and the early withdrawal penalty is more than the interest you've earned so far.
• CD rates can vary widely, meaning you must do your own research before deciding where to open a new CD. Once you're committed, you're committed for the entirety of the CD term -- even if a better rate comes along.
• If you don't remember to cash out a CD before its maturity date, it will roll over into a new CD with the same term (possibly with a lower rate of interest).

Bonds

A bond is a loan, and you're the lender. When a corporation, municipality, or government needs to borrow money, they do so by allowing people to invest in bonds. Bonds are bought and sold on the open market, and their value is determined by a number of factors, including the issuer's credit rating.

Advantages of investing in bonds

• Depending on which entity you're loaning money to, bonds can be quite safe.
• If you're risk-averse, you have the option of choosing a type of bond that is less likely to lose money than others. For example, Treasury bonds are backed by the U.S. government and are considered the safest of all bonds, whereas junk bonds pay a higher rate of interest but are also riskier. Going in, you have a good sense of the risk you're taking.
• Bonds provide a steady income stream through interest payments and may appreciate in value over time.

Disadvantages of investing in bonds

• No bond is 100% safe. While it may be rare to lose money on government-backed bonds, other types of bonds are more prone to loss.
• The composite interest rate on Series I savings bonds is 4.28%, not quite as high as the advertised rates on some CDs. For example, a 5-month CD from Western Alliance Bank currently pays 5.30%.
• Bond values drop as interest rates rise, and there's a good reason for this. Let's say you purchase a bond with a face value of $1,000 that pays 4% interest. Further, imagine that investments like CDs are paying 2.5%. If you decide to sell your bond, chances are investors will be willing to pay more for it because it has a higher fixed interest rate. But what if interest rates are on the rise and CDs suddenly pay 5%? Investors are not going to pay you $1,000 for a bond that earns less interest than they can earn elsewhere.

No bad choice -- as long as your decision aligns with your goals

CDs and bonds are both considered low-risk investment options, especially when compared to stocks. Which one is a better fit for you today depends on your goals. For example:

• If your goal is to earn a higher interest rate, bonds sometimes have CDs beat due to the slightly higher risk associated with bonds. While it's not always the case, it has been a common scenario historically.
• If your goal is to create a steady stream of income, bonds may appeal to you more than CDs.
• If you want to avoid risk altogether, CDs are the clear winner.
• CDs offer more security if you're looking for a place to save money for a predetermined future goal.

Of course, there's no saying you can't diversify your portfolio by investing in both CDs and bonds. As long as you understand the way each works, it's possible to squeeze the maximum from your investment dollars by using both.