CDs vs. Bonds: How to choose

Before investing in either, it helps to understand the differences between the two—including where to buy them, how each generates returns, and the safety mechanisms that work to protect your hard-earned cash.

CDs vs. bonds at a glance

A CD is a type of savings account available from banks where you generally commit a fixed sum for a fixed term. In return, you earn a fixed interest rate until the CD’s maturity date. You may pay an early withdrawal penalty if you withdraw your money before the CD matures.

Bonds are debt investments where you, the bondholder, loan money to a company or government entity, the bond’s issuer. Over the bond’s duration or term, the issuer pays you interest. When the bond matures, the issuer repays your loan by returning your principal.

One important difference to note when comparing CDs vs. bonds is how liquid they are during ownership. With a CD, the only way to access your cash is by cashing it in at the issuing bank. With bonds, selling them before maturity on a secondary market is possible—like at an online brokerage, the U.S. Treasury Department, or through your financial advisor. 

How CDs work 

When you open a CD, you agree to lock up a lump sum with the bank—usually in exchange for a fixed term and a fixed rate of return, called the annual percentage yield (APY). In exchange for your commitment, the bank pays you a higher APY than you would receive on other deposit accounts like high-yield savings or money market accounts. 

You can find CDs in various term lengths, generally ranging from short terms like 3 months to longer terms of 5 years or more. You’ll often find that CDs with longer terms reward you with higher interest rates, which makes up for not having access to your cash for an extended time.

CDs are also insured by the Federal Deposit Insurance Corporation (FDIC), up to $250,000 per depositor, per bank. If you’re concerned about bank failures since 2023 has been an interesting year for those, this insurance offers an extra layer of confidence. 

“A CD may be for someone who likes the comfort of knowing that their investment is insured by the government,” says Shayna Harvey, a certified financial planner and owner of Insight Total Stewardship in Havertown, PA. “If we had a risk spectrum [CDs] would fall on the lower end.” 

CD pros and cons

CDs offer unique advantages and disadvantages to consider before committing your funds. You’ll find higher yields than many savings accounts, but their liquidity challenges might be dealbreakers if you need to access your money before maturity. 

How bonds work

While a wide variety of companies, government entities, and organizations issue bonds, they all do so for the same reason: to raise money. And instead of issuing stock, which is an ownership stake, they issue bonds, loans they’ll ultimately have to repay.

When you buy a bond, you become the lender. You lend a fixed sum to an entity—the borrower—for a fixed term. In return, that entity agrees to pay you interest on your loan throughout the term. Your lender-borrower contract is complete on the bond’s maturity date, and the issuer returns your principal. This process is identical to a personal loan; when a borrower makes the final payment to the lender, the loan is repaid in full, and the lender-borrower contract ends. Here’s a look at how a bond works:

Say you buy 10 5-year corporate bonds with a face value of $1,000 each with a coupon rate (the annual interest rate) of 5%. For your $10,000 loan, you’ll receive annual interest payments of $500 throughout the 5-year term for a total of $2,500. At the end of the 5-year term, the company returns your $10,000. 

If you want to sell your bond before maturity, you can generally do so at the brokerage where you purchased the bond. However, selling a bond before maturity could cost you money—especially if interest rates have increased and new bonds have higher coupon rates than yours.

Bond returns are generally tied to the bond issuer’s creditworthiness (the borrower), just like consumer loans. The lower the risk, the lower the rate of return. “For example, a Treasury bond is less risky than [a bond issued by] a bank or corporate entity because it is backed by the government,” says Kendall Meade, CFP at SoFi, a personal finance company. 

As for buying bonds, you can buy them individually or through investments like bond exchange-traded funds (ETFs) and bond mutual funds. Individual bonds are usually issued in $1,000 increments, and you can’t buy a fraction of a bond. So if you have less than $1,000 to invest, you can build a more diversified portfolio using an ETF or mutual fund.  

Bond pros and cons

Bonds can be a powerful tool to help balance an investment portfolio. They’re typically not as volatile as stocks and offer regular interest payments that make it easy to predict income. But they aren’t without their risks, including default and liquidity.

Bonds vs. CDs: Which is right for you?

When stacking up bonds vs. CDs side-by-side, your best choice will come down to a combination of liquidity needs, risk tolerance, and financial goals. While both investments can be terrific options for income-minded investors, like those in retirement, there are cases where one might make more sense than the other. 

When CDs might be a better choice

• You have a smaller sum to invest. With many CDs offering low minimum investments, you may find it easier to find better rates on CDs than bonds.
• You like the assurance of insurance. Since CDs are FDIC insured, there’s virtually no risk of default.
• Your goals have a clear time horizon. If you’re saving for a wedding in one year or a house down payment in five, you can buy CDs with terms to match your goals.
• You prefer to keep things local. CDs will be a better choice if keeping your accounts consolidated at your current bank is important to you.

When bonds might be a better choice

• You need the tax break. If you live in a state with an income tax, municipal bonds can offer tax breaks that CDs cannot.
• You want flexible liquidity. Since you can sell bonds on the secondary market, they could offer faster access to cash than CDs.
• You’re diversifying a retirement account. Bond ETFs and mutual funds can quickly add diversity to your 401(k) or individual retirement account (IRA).

The takeaway

If you’re looking for safety and predictability with your investments, CDs and bonds can offer both. However, CDs may ultimately be better for those who prefer the comfort of an insured investment. Bonds could be a better choice for those needing the tax advantages that municipal bonds offer. And don’t forget—there’s likely room for both in your investment portfolio. If you want extra guidance to help you make the best choice, stop by your local bank or speak to a financial advisor.