CDs vs Bonds: Which Is Better?

last updated 30 October 2024

Trying to decide between investing in a CD or a bond? Both offer you a secure way to earn a return. The returns will usually be modest relative to other investments, but both offer investment safety with steady returns.

The Fed has signaled that it expects to cut rates in 2024, but hasn’t said when it will begin its rate-cutting cycle. Although the higher Fed rate is bad news for people paying down debt — it has been a boon for savers, resulting in beefy interest rates on high-yield accounts and CDs. So, locking in the 5%+ returns before the Fed rate cuts begin would be wise.

Assessing risk, potential return and term of the investment will help you decide between a CD or a bond. Weighing the differences is essential to finding the right fit for you and your money.

What is a certificate of deposit (CD)?

CDs are a type of savings account you can open at a bank or credit union. CDs are insured by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA) up to $250,000 per account, reducing your risk to zero.

When you open a CD, you agree to leave the money on deposit for a set amount of time or incur a penalty for withdrawing funds early. In exchange, the bank pays you a fixed annual percentage yield (APY), making CDs a safe, predictable way to grow your money. Terms can run anywhere from three months to five years.

When to choose a CD

Can help you reliably save for the near future. Deciding how long to keep your money on deposit is crucial because there are penalties for an early withdrawal. A three- or five-year CD could help you save for an extended vacation or for the down payment on a home. CDs with a shorter term can help you accumulate earnings to build an emergency fund or gain fiscal discipline by putting the money temporarily out of reach.

Popular when interest rates are high. A crucial difference between CDs and bonds lies in how CDs react to increased interest rates. When interest rates rise, the APY usually increases. That means that CD rates offered by banks go up when the interest rates climb.

The Fed interest rate increases have forced banks to hike interest rates offered on CDs. The 3-month, 6-month and 1-year CDs offer the best rates, anywhere from 4.50% to 5.10%. In the short-term, bonds can't compete with those return rates.

Risk adverse. CDs might be a better option for the most risk-averse investors. They’re ideal for reaching short-term savings goals because you can choose from a variety of term lengths. CDs are great if you have a savings goal because you can earn more interest than a typical savings account without locking your money away for too long or risk losing it.

Terms vary by bank. Make sure to compare interest rates, early withdrawal penalties and the amount of time you’re willing to lock your cash away, before opening a CD. No-penalty CDs can be useful when there is a possibility you may need the principal back sooner than a given CD term.

Below you can compare current CD rates below with our new tool, in partnership with Bankrate.

What is a bond?

Bonds are debt obligations issued by governments, government agencies and corporations used to raise capital or operating expenses. When you buy a bond, you are making a loan to the issuer and the issuer promises to pay you periodic interest payments (coupon) and to repay the face value of the bond (par value) upon maturity.

What do you get when you buy a bond?

When you buy a bond, you receive periodic interest payments known as coupons. The coupon payments, which may be made quarterly, twice yearly or annually, are expected to provide regular, predictable income to you. Longer maturity terms make bonds a lower maintenance investment. You can lock in a stream of income for up to 30 years and avoid having to seek reinvestment at a potentially lower rate.

Bonds are not FDIC-insured and come with some risk. When buying corporate bonds, you can manage the risk by buying investment-grade bonds that have earned a high rating from the credit-rating agencies. The least risky are Treasury bonds and U.S. savings bonds that are backed by the full faith and credit of the U.S. government.

Government bonds can be purchased directly at Treasurydirect.gov. You can buy Treasury bonds and savings bonds directly from the federal government without any fees. They can also be purchased through a brokerage.

When to choose bonds

Popular when interest rates are low. A crucial difference between CDs and bonds lies in how they react to increased interest rates. When interest rates rise, bond prices decrease. That means that a bond will lose market value if interest rates rise. That is, if you sold the bond on the secondary market, it would go for less because other bonds would be available that pay a higher rate of return.

After increasing rates 11 times since March 2022, the Fed has started cutting rates. The first rate cut was after their September meeting. The fed rate was cut by .5% or 50 basis points. Over time, as rates are cut further, bonds will become more appealing. CD rates have already dropped and will go down with every rate cut. However, you can still earn 5% and over on three and six-month CDs.

Higher risk tolerance. If you are more risk-tolerant and looking for greater returns, you might prefer to put your money in bonds. Most bonds pay a steady income, so they’re useful if you are looking for a fixed income stream.

Diversification. And bonds can also be used to diversify your investment portfolio and help hedge your investments against the fluctuations in the stock market.

Bottom line bonds vs CDs

CDs and bonds may offer smaller returns, but they carry little or no risk of principal loss. Both require you to “lock-up” your money for a specified period to receive the maximum return and avoid possible penalties. Important factors to consider are your risk tolerance and how potential returns compare between CDs and bonds.

CDs have minimal risk and have more flexibility compared to bonds with respect to how long you need to put your money out of reach. Bonds carry more risk. The issuer could default and changes in interest rates could devalue your investment. But, government bonds are considered risk-proof and receive favorable tax treatment.

Short-term investors should give CDs a close look. You can buy a CD with a three-month term if you are undecided or need the money back in your hands sooner rather than later.

Long-term investors may see bonds as a better option. Especially when you are saving for education. U.S. savings bonds are easy to buy, the minimum investment is $25, and you might be able to avoid federal tax on the interest if you use them for qualified education expenses.

Donna joined Kiplinger as a personal finance writer in 2023. She spent more than a decade as the contributing editor of J.K.Lasser's Your Income Tax Guide and edited state specific legal treatises at ALM Media. She has shared her expertise as a guest on Bloomberg, CNN, Fox, NPR, CNBC and many other media outlets around the nation.