Market swings can make it harder to feel confident about where to put your money. For those looking to avoid the ups and downs of stocks, bonds and Certificates of Deposit (CDs) may offer more stability. However, while both are often seen as lower-risk investments, they work in different ways, each with its own level of flexibility, return potential, and risk.

Understanding the key differences between bonds vs. CDs may help you determine which one aligns with your financial goals and needs. This guide takes a close look at how each option works, along with its potential benefits and limitations, so you can make an informed decision.

Key Differences Between Bonds Vs. CDs

  • Interest Rates and Returns: Bonds often have higher interest rates than CDs.
  • Liquidity and Access to Funds: CDs typically incur penalties for early withdrawals, while bonds can be sold before maturity without penalty; however, you may incur a loss if the price of the bond is below the purchase price.
  • Income Stream: Bond interest is typically paid quarterly or monthly. Depending on the financial institution, interest paid on CDs may only be accessible at maturity.
  • Risk of Loss: CDs are insured by the Federal Deposit Insurance Corporation (FDIC)  up to the maximum limit, while bonds carry the risk of issuer default.
  • Diversification: Bonds offer a wider range of options (government, municipal, corporate), allowing for more diversification than CDs.
          Bonds CDs
Issuer and Type Governments and corporations. Banks or credit unions.
Interest Rates and Returns Typically higher than CDS. Varies by issuer and market conditions. Fixed rate. Generally lower than bonds.
Risk and Safety Subject to market risk and issuer default. Low risk. insured by the FDIC.
Liquidity and Access to Funds Can be sold before maturity, though may result in a loss. Funds are locked until maturity. Early withdrawals usually incur penalties.
Income Stream Interest typically paid semiannually. Interest may compound but is often only accessible at maturity.
Investment Term Ranges from short-term to 30+ years. Typically ranges from a few months to 10 years.
Minimum Investment Varies. Often starts around $1,000 or more. Varies by bank. May be as low as $500.
Tax Implications Corporate: Taxed as ordinary income; Treasurt: Exempt from state and local taxes. Interest taxed as ordinary income.

What Is A CD?

A CD is an investment vehicle offered by banks and credit unions. CDs offer higher interest rates than a standard savings account, however, they typically require you to deposit a sum of money for a fixed term, which can range from a few days to up to 10 years. 

Generally, CDs with longer terms offer higher interest rates. When you invest in a CD, you agree not to access the funds until the end of the term, known as the maturity date. At maturity, you can either withdraw your initial deposit, along with the accrued interest or roll the funds over into a new CD.  

Reasons To Consider A CD

CDs are often considered one of the safest investment vehicles available. They are backed by the FDIC, meaning that in the event of a bank failure, your investment is secure up to the legal limit. That means if the issuing bank fails, the principal and earned interest are protected (up to the limit), regardless of what happens in the broader economy or financial markets.

This layer of protection makes CDs particularly attractive to those focused on preserving capital. Unlike stocks or bonds, the value of a CD doesn’t fluctuate with market movements. And thanks to the FDIC, CDs are viewed as a safer option than cash held outside of a bank. 

Since the interest rates on CDs are typically higher than savings accounts, they can be attractive to those looking to earn a stable return with little to no volatility. The fixed interest rate makes it easy to calculate the amount you will earn over the CD’s term. Since CDs offer a variety of term lengths, you can have the flexibility to choose a duration that best fits your financial timeline and goals. 

Potential Drawbacks   

Despite their safety and reliability, CDs have some limitations. Consider these important risks before investing in a CD. 

Inflation Risk

The fixed rate of a CD means your earnings won’t rise if inflation does. Over time, especially during periods of high inflation, this may reduce the real-world value of your money. While you’ll earn interest, your purchasing power may shrink if prices increase faster than your return.

For example, if you invest $1,000 in a CD with a five-year term, by the time it matures, inflation could have significantly increased the cost of goods and services, reducing what that $1,000 can buy. While your balance grows due to the interest earned, your investment could decrease in terms of real-world buying power.

This risk is more pronounced with longer-term CDs. If you lock in a rate today and inflation climbs steadily over the next several years, the balance of the CD may be higher, but there's a chance it could buy less. 

Liquidity Risk

CDs require you to keep funds locked in for a set term, which can limit flexibility. Withdrawing money before the maturity date typically triggers a penalty. Depending on the bank, this may require forfeiting some or all of the interest earned, or, in some cases, dipping into the principal.

For this reason, CDs may not be ideal if you anticipate needing the money before the term ends. Before opening a CD, make sure you have other liquid savings set aside for emergencies or unexpected costs.

What Is A Bond?

A bond, or fixed-income security,  is a type of investment vehicle that functions similarly to a loan. When you purchase a bond, you are essentially lending money to an entity, such as a government or corporation. In exchange, the entity agrees to pay you back the full amount on a predetermined future date, known as the maturity date. Along the way, they also pay you interest, typically at regular intervals. 

Bonds are available through banks, brokerage firms, and sometimes directly from the issuer. They come in various forms, with terms ranging from short to long durations, often spanning several years. The interest rate on a bond can be set in different ways. It can remain fixed throughout the term, change with market rates, or even vary based on specific conditions. 

Reasons To Consider A Bond

Bonds often offer higher interest rates than CDs, which may be appealing to those looking for a higher profit potential. Unlike CDs, where interest may accumulate and only be paid at maturity, bonds often provide ongoing interest payments, usually at monthly or quarterly intervals. This consistent income can be an advantage for individuals, such as retirees, who rely on investments for regular cash flow.

There are different types of bonds, from government-issued bonds, which are typically considered the safest, to corporate bonds, which pay higher interest rates to offset additional risk. This range of options allows you to choose a bond that aligns with your financial goals and risk tolerance, adding a layer of diversification to your investments that CDs may not offer. Some bonds, such as municipal bonds, may also offer tax-free interest payments. 

Unlike CDs, which often incur penalties if you access your funds before maturity, bonds offer more flexibility. You have the option to sell bonds at any time before they mature, without facing penalties. This sale takes place in the secondary market, where you can sell your bonds to other investors, allowing you to access your funds whenever you need them.

Potential Drawbacks

While bonds are generally considered a safe investment compared to other options, such as stocks and mutual funds, there are several potential drawbacks you need to consider before making a purchase. 

Interest Rate Sensitivity

Bonds are subject to interest rate sensitivity. When market interest rates rise, new bonds may be offered at higher rates, making older bonds less attractive and decreasing their value.  

If you sell a bond before its maturity date in a rising interest rate environment, you may have to sell it at a lower price than what you paid, potentially incurring a loss. However, if you hold the bond until maturity, you'll receive all agreed-upon interest payments as well as the full principal amount, regardless of any interest rate changes that have occurred during the holding period. 

Default Risk

There’s a risk that the bond issuer, such as a corporation or government, could fail to make scheduled interest payments or repay the principal at maturity. This is known as default risk. While government bonds typically have low default risk, corporate bonds can vary significantly based on the company’s financial stability. Bond ratings, provided by agencies like Moody's and Standard & Poor's, help investors assess the stability and creditworthiness of the bond before investing. Bonds with higher ratings have lower default risk. 

Inflation Risk

Inflation erodes the purchasing power of future interest payments. Even if your bond pays a fixed rate, rising prices can diminish the real value of those payments over time. This is especially relevant for long-term bonds, where inflation has more time to compound its effect. While bonds can provide a reliable income stream, they may not be the best hedge against inflation, unless they are indexed to inflation or part of a broader, diversified portfolio designed to manage this risk.

Risk Comparison: CD Vs. Bonds

Risk Type Bonds CDs
Interest Rate Risk High: Bond prices typically when interest rates rise. Moderate: Missed opportunity if rates rise after locking in.
Default Risk Varies: Corporate bonds carry risk. Government bonds are typically safer. Low: FDIC insured up to the legal limit.
Inflation Risk Moderate to high: Fixed payments may lose value over time. Moderate: Interest may not keep pace with inflation.

Tax Implications: CDs Vs. Bonds

While the interest earned on CDs is typically taxed as ordinary income, the tax treatment of bonds varies depending on the issuer. Corporate bonds are taxed the same as CDs, meaning the interest is taxed as ordinary income. However, the interest on treasury bonds (issued by the U.S. government) is subject to federal income tax and is exempt from state and local taxes. Municipal bonds (issued by state, city, county, and other local government entities) are often exempt from federal income tax and may also be free from state and local taxes if they are purchased from your home state. 

The Bottom Line

A CD can be an attractive option if you have funds you do not need to access immediately and want to earn interest while also ensuring your investment is safe. However, since CDs may not keep up with inflation, they may be more suitable for short-term financial goals rather than long-term growth.

Bonds may be appropriate if you’re looking for an investment with a higher earning potential compared to CDs and the added flexibility of being able to sell your investment prior to maturity. However, it’s important to understand and carefully consider the potential risks. Generally, bonds are suitable for medium to long-term investment goals, offering a balance between stability and growth in a diversified portfolio.

Explore Your Investment Choices With PNC 

When considering bonds vs. CDs, it's important to evaluate how they align with your financial needs, risk tolerances, and goals. With fixed returns and the safety of FDIC insurance, CDs can be an excellent choice the short term. Bonds provide higher yields and offer more flexibility, making them suitable for investors with medium to long-term time horizons.