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Part of the Series Certificate of Deposit (CD) GuideInvesting With CDs
CDs vs. Other Financial Products
Certificates of deposit (CDs) and bonds are similar but not identical. They are both fixed-income securities that the investor holds onto until their maturity dates. The investor puts money into a CD or a bond for a set period of time, and they get their money back when the time is up.
The investor is also paid interest. Both CDs and bonds are debt-based securities, and the investor is the creditor.
It’s really no different than having a friend ask for a $10 loan today and give you an IOU promising to pay $11 next week. The $1 interest is collected for the same reason that banks charge interest on loans: to compensate you for delaying your ability to make use of the money. You can’t spend that $10 when you don’t have it.
Bonds and CDs fit under the same broad category of investment vehicles. Here’s how they differ.
Bonds are issued by companies or governments when they want to raise funds, for their ordinary operations or for a special project.
All bonds are awarded a rating by a bond rating agency according to the likelihood that the company or government that issues the bonds will default on their debts. There is a very low default risk for investment-grade bonds and a greater risk for so-called junk bonds.
The lower the risk, the lower the interest rate that the issuer will have to offer to find takers for their bonds.
The issuer of a CD is usually a bank or a credit union. It is more like a savings account than a loan.
Like a savings account, money in a CD is guaranteed by the Federal Deposit Insurance Corp. (FDIC) for deposits up to $250,000. Because it is literally as safe as the U.S. Mint, the CD pays a very modest interest rate.
The rate of return is a little better than a traditional savings account because the investor has promised to keep that money on deposit for a period of time, ranging from one month to five years. The investor can get the money out early only with a penalty.
The rate of return is lower than bonds would pay. The reason is the absence of risk.
As of May 18, 2022, the average interest rate was 0.24% for a one-year CD and 0.43% for a five-year CD.
People often refer to any fixed-income security as a bond, but that is technically incorrect. Bonds generally mature after 10 or more years, while CDs and other fixed-income securities tend to have shorter maturities.
This is the sticky—but also the most significant—part. Bonds are longer-term investments, with many maturing after 10 years or more. CDs mature in as little as one month, although they may go for five or even 10 years.
There are further distinctions or categories within the world of fixed-income debt securities. The loose categorization is as follows:
In other words, while a bond is technically a fixed-income security with a maturity of 10 years or more, people often use the term bond to refer to fixed-income securities in general—even for those securities with a maturity of fewer than 10 years.
Bond issuers are primarily companies or governments raising money for their operations or for special projects. Banks and credit unions are the main issuers of certificates of deposit (CDs).
A CD is similar to a savings account. It’s a place to keep your money safe until you want to do something else with it.
Standard CDs are insured by the Federal Deposit Insurance Corp. (FDIC) up to $250,000, per depositor, per FDIC-insured bank, per ownership category, so they can’t lose value.
Bonds are generally longer-term investments, generally maturing after more than 10 years. CDs mature in as little as one month and in as many as 10 years.
The difference in time commitment for bonds and CDs is best expressed in terms of the investor’s motives. CDs are short-term, low-risk, interest-paying storage for money until a more profitable investment or a better use for the money can be found. Bonds are long-term vehicles for a guaranteed profit and, for many investors, a safer haven to offset the risks of losses in other investments such as stocks.
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Description Part of the Series Certificate of Deposit (CD) GuideInvesting With CDs
CDs vs. Other Financial Products
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A payment-in-kind bond is a type of bond that pays interest in additional bonds rather than in cash. PIK bonds are typically issued by companies facing financial distress.
A war bond is is a form of government debt that seeks to raise capital from the public to fund war efforts.
A variable rate demand note is a debt instrument that represents funds that are payable on demand and accrue interest based on the money market rate.
An agency bond is a debt security issued by a federal government department or by a government-sponsored enterprise such as Freddie Mac or Fannie Mae.
Industrial revenue bonds are municipal debt securities issued by a government agency on behalf of a private sector company and intended to build or acquire factories or tools.
A CD ladder is an investing strategy which you buy multiple certificates of deposit (CDs) with different maturity dates. Learn how to build a CD ladder.
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