I Bonds vs. CDs: Which Are Better?

With recent increases in interest rates and persistent inflationary pressures, the good news is that savers have several ways to maximize the yield from their savings. Two excellent options are inflation-protected savings bonds, or I bonds, and certificates of deposit, or CDs. In this article, we'll take a look at the pros and cons of each to see if one might be a better fit for you.

What are I bonds?

Series I Savings Bonds, or I bonds, are special savings bonds designed to protect their owners from the effects of inflation on their money.

I bonds have interest rates that have two components. There is a fixed interest rate that depends on the interest environment when the bond was issued, which stays the same for the life of the bond. Then, an inflation adjustment is added to produce the total yield. This component changes every six months according to recent inflation data.

I bonds can be purchased directly from the U.S. Treasury online, and individuals can buy as much as $10,000 in I bonds each year.

Currently, the I bond yield is 4.3%, of which 0.9% is a fixed rate that lasts as long as the bond does, and a 3.4% inflation adjustment. This rate applies to all I bonds sold through the end of October 2023, and will remain the same for the first six months of the bond's existence.

Advantages of using I bonds

The biggest advantage to putting some of your money into I bonds is rather obvious -- it will help your savings keep up with inflation over time.

CD interest rates are simply based on prevailing market interest rates, are set by the banks, and may or may not keep up with inflation over time. On the other hand, I bond interest rates are specifically designed to keep up with inflation -- for example, when inflation spiked in mid-2022, I bond interest rates were set at 9.62%, while you would have been lucky to find a CD with one-third of that APY at the time.

Disadvantages of I bonds

There are a few big drawbacks to buying I Bonds that you should be aware of. First is the $10,000 annual limit, which doesn't exist with CDs. In fact, some of the best yields you can find are on "jumbo" CDs, which often require deposits of $100,000 or more.

It's also important to realize that you cannot cash out for at least one year. With CDs, you can get your money back at any time if you're willing to pay a penalty, but I bonds cannot be redeemed for at least one year. And if you cash out an I bond within the first five years, you'll pay a penalty. In a nutshell, I bonds are best used to protect against the long-term effects of inflation.

Advantages of CDs

CDs are offered by banks and they allow you to lock in a specific yield for a set period of time. I bond yields reset every six months, depending on inflation. But with CDs, you can lock in the same yield for five years, or even longer if you want. And depending on the state of inflation and consumer interest rates, you may be able to find CDs with higher yields than the current I Bond yield.

In fact, some of our favorite banks offer one-year CDs with yields over 5% as of this writing. As mentioned earlier, the current I bond yield is 4.3%.

Potential drawbacks of CDs

One of the biggest upsides of using CDs is also one of the biggest potential drawbacks, especially when it comes to CDs with multi-year terms. I'm talking about interest rates. Let's say you get a 5-year CD with a 4% APY, so you're locked into this rate for five years. If the bank's 5-year CD rate falls to 2% next year, you still get the same 4% yield. But what if rates soar and the bank's 5-year CD rate is 8% a year from now?

I bond interest rates reset every six months, allowing you to benefit if the prevailing inflation rate spikes. But with CDs, you're locked in, which can be a good or bad thing.

In addition, many CDs have minimum deposit amounts that could be prohibitively high in some cases. On the other hand, I bonds can be bought in quantities as small as $25.

Which is the better choice for you?

To be perfectly clear, both I bonds and CDs can be excellent ways to get more return from your savings, and with little additional risk. However, it's important to understand the differences between these two savings vehicles and to consider all of the pros and cons before deciding.