Bond vs. CD: Which Is a Better Investment?

Both bonds and certificates of deposit (CDs) can be safe places to stash cash, but each has its own distinct benefits and drawbacks. A CD tends to be a better place to keep savings for short-term goals. CDs are also lower risk than most bonds. Meanwhile, bonds are best for generating regular income, especially if you're looking to keep your tax bill low.

Here’s how to evaluate a CD versus a bond to help you choose the right one for your financial goals.

CDs vs. bonds at a glance

What’s the difference between a CD and a bond?

A CD is a time deposit you make with a bank or credit union. In contrast, a bond is a loan you make to the issuer in return for regular interest payments.

You buy a bond through the Treasury or a brokerage firm, whereas you open a CD account at a bank or credit union. Both products earn a fixed interest rate over the stated term.

One key difference: Most CDs cannot be sold before maturity, but bonds can.

What is a CD?

A CD is a type of savings account in which you agree to keep your money for a specified length of time. In return, the bank or credit union will pay an interest rate that is typically higher than what you could earn from a traditional savings account.

CDs can have term lengths of one month up to 10 years, and the yield you earn will often vary by term length. When your CD matures, you will receive your initial investment plus any interest earnings. However, you'll often face a penalty if you try to withdraw from your CD before it matures, with the exception being no-penalty CDs.

CDs can be safe, provided you purchase them through a federally insured institution. Banks should be covered by the Federal Deposit Insurance Corp. (FDIC) and credit unions by the National Credit Union Administration (NCUA). These institutions will insure your CD account up to $250,000.

What is a bond?

A bond is easiest to understand if you think of it as an IOU. When you buy a bond, you are lending the issuer your money for the life of the bond — or until it matures. In return, the issuer agrees to pay you interest and repay the principal on the bond when it matures.

Most bonds pay interest semiannually. Still, some types pay more frequently, and others may not pay any interest until maturity.

There are different types of bonds based on the issuer and risk-level. Corporations, municipalities and governments, for instance, issue bonds to raise funds for various projects.

The biggest risk to these securities is that the issuer defaults and stops making payments on its debt. Issuers with a greater chance of default are considered riskier and, as a result, typically offer higher interest rates on their bonds.

For example, corporate bonds tend to be riskier than government bonds because corporations are more likely to face financial hardships. That means corporate bonds often pay a higher rate.

You can gauge a bond's risk level based on its credit rating. Three major credit-rating agencies score bonds: Fitch, Moody's and Standard & Poor's.

Each uses a slightly different scale, but all can be segregated into investment-grade or noninvestment grade, also called high-yield or junk bonds. Investment-grade bonds are less risky than noninvestment grade bonds.

Unlike CDs, you can sell a bond before it matures without penalty. Doing so means you won’t receive any future interest payments or your principal at maturity. In addition, the price you receive for your bond may be higher or lower than what you paid.

Pros and cons of CDs

Pros and cons of bonds

When to consider CDs

A CD may not provide as much flexibility as a bond, as you're locked in for the duration of the CD term. However, depending on your goals, CDs may be a good fit for you. Here are some circumstances in which you may want to consider a CD for your savings:

• You want a safe place to stash cash. Because CDs are insured for up to $250,000, you are virtually guaranteed to get your money back at the end of the term. Banks and credit unions are unlikely to default, but if they do, the FDIC or NCUA will step in to make you whole. This makes CDs one of the safest places for your savings, alongside traditional checking and savings accounts.
• You're saving for a specific short-term goal. If you have a goal in mind that you're saving for within the next five years, a CD can be a great place to keep these funds. You'll earn a fixed rate of return, so you'll know exactly how much cash you'll have at the CD’s maturity date.
• You think interest rates will decrease. If you think interest rates are about to decline, this could be a good time to lock in higher current rates with a CD. Because no one can know for certain what the future holds, you may want to purchase multiple CDs with different maturities and yields — known as a CD ladder — to cover your bases.

When to consider bonds

Bonds come with more risk than CDs, and they’re not insured by the FDIC or NCUA. However, they can also provide more flexibility and higher returns. Here are some circumstances in which you may want to consider investing in bonds:

• You want a steady income. Bonds can be a great source of regular income because they pay interest on a fixed schedule. If you hold the bond until maturity, you'll also get your initial investment back.
• You want tax-exempt income. CD interest is taxed at ordinary income rates, unless it’s held in an IRA. Some types of bonds pay interest that’s exempt from federal and/or state income taxes. For example, interest on Treasury bonds is exempt from state and local taxes. Municipal bond interest is exempt from federal taxes as well as state taxes for residents.
• You want to minimize volatility in your investment portfolio. Bonds are often used as a complement to stocks in investor portfolios, as they tend to provide more stable returns. This can help balance out the greater price fluctuations you're likely to experience with a stock portfolio and make your overall investing journey less bumpy.
• You need more liquidity than a CD. Because bonds can be sold before maturity on the secondary market without penalty, they may be easier to liquidate than a CD. That said, you will need someone willing to buy your bond, and there's no guarantee you'll get back as much as you paid.

Factors when choosing between bonds and CDs

Even knowing all the features of CDs and bonds, it can be hard to choose between these two products. Here are some factors to consider when choosing between a CD versus a bond:

Financial goal

What is your goal for these funds? If you're saving for a specific purchase in the near future, a CD may be a good choice, as these provide guaranteed returns. However, if you're just looking for regular income or to reduce portfolio volatility over the long term, bonds may be the better option.

Time frame

How long is your financial goal timeline? If you have a near-term goal — say, within the next five years — minimizing risk is paramount. But if you have a more long-term goal in mind, you may be able to take a bit more risk in return for a higher potential reward.

Risk tolerance

How much risk are you willing to take with your funds? Bonds are riskier than CDs. They aren’t insured, and they’re also subject to interest rate and price risk.

That said, bond issuers will have differing levels of risk. For example, Treasury bonds issued by the U.S. government are considered among the safest securities. Junk bonds, on the other hand, come at a higher risk but could also lead to a greater reward because of higher interest rates.

Liquidity needs

The early withdrawal penalties on most CDs can make them unsuitable if you may need access to your funds before the maturity date. Bonds don't have these penalties, so you may have an easier time unlocking your cash if you need it earlier than anticipated. However, it may not always be easy or lucrative to sell your bond before its maturity date: Invest with caution.

Ultimately, whether you should use a CD versus a bond comes down to your financial situation and goals as well as risk tolerance. Each of these factors listed above are key considerations, but their relative importance in your decision-making process will depend on what matters most to you.