Bonds vs. CDs: How they compare and which is better for you

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• Bonds and CDs are both fixed-interest, low-risk investment instruments.
• CDs are FDIC-insured but bonds aren’t; CDs often have shorter maturity dates than bonds.
• CDs could be a good fit for short-term investors who don’t want to risk losing principal; bonds may be better for long-term investors or those seeking tax-free income.

If you’re looking for investments that can provide a steady income stream, bonds and CDs are two strong choices. While both are likely to underperform riskier investments like dividend stocks or real estate in the long term, they also generally offer more safety and stability.

Bonds and CDs have a lot in common. But there are times when one may be a better choice than the other.

It’s important to know the differences so that you choose the fixed-income investment that best suits your needs. Here’s a rundown of the key features of each, and how to opt for one over the other. 

Bonds vs. CDs: Definitions

What is a bond?

A bond is a security that represents debt. So you can think of it as a loan that investors make to large entities, like governments or companies. In return for borrowing your money, the bond issuer promises to pay a certain interest rate over a set period of time — in addition to repaying the principal amount when the bond reaches maturity.

What is a CD?

A certificate of deposit (CD) is actually a type of savings account offered by banks. With a CD, you promise to keep your money in the account for a specific period of time (usually from a few months to five years). In exchange, the bank promises to pay a fixed interest rate that is often higher than it offers on its traditional savings account. 

Many CDs will generally charge an early withdrawal penalty if you take out your money before the account’s maturity date. However, some banks do offer no-penalty CD products. 

See Insider’s best CD rates>>

Key differences between bonds and CDs

From a strategic standpoint, here are the main features that differentiate bonds and CDs:

Bonds trade on markets, CDs don’t

While investors can choose to hold their bonds until maturity, many can also be sold beforehand on the secondary market. As a general rule, bond prices have an inverse relationship with interest rates. So when interest rates go down, bond prices tend to go up and vice versa.

CDs are insured, bonds are not

CDs come with FDIC insurance of up to $250,000 per account-holder. And credit unions, which offer their own version of CDs called “share certificates,” also carry $250,000 of federal insurance via the National Credit Union Share Insurance Fund.

Municipal bonds and corporate bonds don’t come with this kind of federal insurance protection. So if you lend money to a company that later finds itself in financial straits, it may be unable to fulfill its debt obligations.

This means that some bonds are riskier investments than CDs. However, it should be noted that Treasury bonds are backed by the same federal government that funds the FDIC (Federal Deposit Insurance Corporation). For this reason, federal bonds and CDs carry virtually the same (very low) level of risk.

Bonds are often tax-advantaged, CDs are not

CD income is generally taxed as normal income. So, if you happen to be in the 24% tax bracket, you’d need to pay $24 in taxes for every $100 of CD interest payments you accrue.

However, bonds issued by the government often come with tax advantages. For example, Treasury bond investors are only required to pay federal taxes on their interest payments, but not state. The exemption from local taxes could provide significant savings for investors who live in high income-tax states.

Municipal bonds come with great tax-saving benefits too. Income from these bonds is completely exempt from federal taxes and may be excluded from state and local taxes as well (if you buy one from the state you reside and file in). 

CDs typically have shorter maturity dates than bonds

Many bonds have long-term maturity dates of 10 years or more. For example, Treasury bonds mature in 20 to 30 years. Meanwhile, CDs usually mature within 5 years, with a few banks offering longer CDs of up to 10 years.

How to decide between bonds and CDs

Whether you’re looking to increase your savings yield or hedge against stock market volatility, both bonds and CDs can be valuable additions to a diversified portfolio. But each has its own advantages and disadvantages.

To decide which is right for you, you’ll need to consider your income needs, investment time horizon, and your opinion about the future direction of interest rates. To help you figure out the best option, here’s an in-depth overview of when CDs may be better than bonds, and vice versa.

When to consider CDs

You think that interest rates will soon go up

Compared to traditional savings accounts, CDs are not a great place to have your money stashed in an increasing interest-rate environment. Savings accounts can raise their rates at any time, while your CD rates won’t change after account opening.

But CDs are actually a safer bet than bonds when interest rates are going up. Why? Because the yield for bonds trading on the secondary financial markets will decrease as interest rates rise. But since CDs aren’t traded on markets, their yields aren’t diminished by rising rates. 

If you expect rates to rise, buying short-term CDs for the foreseeable future may be the way to go. In this way, you can lock in your current yield while also giving yourself the flexibility to open new (and, hopefully, higher-yield) CDs each time an account reaches maturity.

You don’t want to risk losing any principal

With a CD, it’s highly unlikely that you will lose any of your initial investment. Even if you have to pay an early withdrawal penalty, the fee is typically calculated as a portion of the interest that you would have accrued over a certain period of time. Depending on how long you’ve held the account, that forfeiture of interest may not cut into your principal at all.

Selling bonds before their maturity date, on the other hand, can be trickier. If the current interest rates being offered on bonds are higher than what yours pays, you’ll need to sell yours at a discount in order to attract a buyer. If you want complete protection from this kind of volatility, opening a CD account will be your better option.

You have a short-term investment horizon

It’s true that there are some short-term bonds that come with durations of one to four years. But if you expect to withdraw your money that quickly, a CD may be the simpler investment vehicle. Plus, with a CD, you won’t have to worry about incurring any trade transaction costs. 

See Insider’s best 6 month CD rates>>

When to consider bonds

You think that think interest rates will soon go down

In a decreasing interest rate environment, bond yields typically increase. So if you feel like rates are primed to fall, choosing bonds over CDs could be a smart choice.

You prize liquidity

Unlike CDs, you’re never locked in with bonds — you can sell at any time, should your goals or needs change. Depending on where prevailing interest rates are, you could even sell it at a premium, realizing a nice little capital gain. 

You want to minimize the taxes you pay on your investment income

Due to their tax advantages, federal and municipal bonds will leave you with more money in your pocket than a CD offering the exact same interest rate. 

The difference will be most pronounced for investors in high tax brackets. Be sure to calculate the after-tax returns of bonds and CDs when comparing your options.

You have a long-term investment horizon

With many bonds having maturity dates of 10 to 30 years, they can be a great “set it and forget it” option for long-term investors who want to protect themselves against stock market volatility.

For instance, a 30-year-old investor may choose a 70/30 (70% stocks/30% bonds) asset allocation for their investment portfolio. While this investor could technically continue buying new CDs every 5 to 10 years to provide a similar cushion against market volatility, that would take a lot more work. 

Plus, investing in bonds over CD is simpler if you’re looking to keep all of your retirement funds in the same 401(k) or IRA account.