Certificates of Deposit (CDs) vs. Bonds
Updated: Aug 1, 2021
Why would anyone ever buy a CD?
How anyone could buy a CD when they could easily buy a bond is just beyond me. Why in the world would you ever do that?
You've probably heard about CDs or seen banks post little signs in their windows advertising the rates on CDs. But what are they?
A CD is a savings vehicle sold by banks and credit unions. You buy a certificate for a certain amount of dollars, for a specific length of time, for a specific rate of interest. The big benefit of CDs is they pay higher interest rates than savings accounts and money market accounts. Yet, it's nowhere near the interest rate that a bond pays.
To get that higher CD interest rate, you promise to not withdraw the money from the bank for a specific length of time, which can be anywhere from three to 18 months, or years.
For instance, if you want to buy a $1,000 CD, and leave it with the bank for 12 months, the highest interest rate you could possibly receive today (July 22, 2021), better known as the annual percentage yield (APY), would be 80 basis points, or 0.8%. (One hundred basis points equal one percentage point.) At the end of the year you would receive an interest payment of $8.00. ($1,000 x 0.008 [0.8%])
That's a horrible rate of return and yet, that's the best available, according to Investopedia. The national average APY, according to Investopedia, is just 0.14%. That would pay an annual interest payment of just $1.40.
The second big benefit to CDs is that they are very safe. When the CD matures, you can expect to receive your principal back with the interest. Even if the bank goes bust, the government insures $250,000 of your money. The only way you could lose money from a CD is if you break your agreement with the bank, by withdrawing your money before the certificate expires.
Now, let's look at bonds. When you buy a bond, you're loaning money to a corporation, or a government. Much like the CD, the two main benefits of bonds are they pay consistent interest income, and they pledge to pay back your principal in full if you hold to maturity.
To do an apples-to-apples comparison, we'll look at U.S. Treasurys, considered the safest bonds in the world, because the U.S. government backs them. The one-year U.S. Treasury bill pays an interest rate of 70 basis points, or 0.07%. So, a $1,000 12-month bill would pay $7 interest ($1,000 x 0.007 [0.07%] = $7). So, the CD could possibly pay more, if you find the best APY in the nation, but it probably won't. Meanwhile, the 10-year U.S. Treasury bond pays an APY of 1.30%, for an annual return of $13.00.
I know, you're saying, "Of course, the 10-year pays more. It's a longer period of time. My money is only locked up in the CD for a year." True, but your money isn't locked up in the bond. You can sell it at any time.
If you decide to lend money to a corporation, you will get an even higher interest rate than either the CD or U.S. Treasury.
The average APY for the safest corporate bonds is 2.54%, according to Moody's. While you may scoff at such a low interest rate, it's nearly four times bigger than that CD or Treasury bond. Riskier bonds pay much more, according to my story, 3 Bonds with Yields as High as 8%.
Pays a guaranteed higher interest rate than savings accounts and money market funds.
The value of the CD is constant throughout the life of the certificate.
You get your principal investment returned in full when the CD matures.
It's extremely safe. The U.S. Government guarantees accounts up to $250,000.
It prevents you from spending the money because it's locked up.
Corporate bonds pay a consistent higher interest rate than CDs. and U.S. Treasury bonds.
You get your principal returned in full when the bond matures.
The riskiness of bonds is determined by the health of the company issuing the bond. Extremely safe corporates still pay a higher APY than CDs.
You can buy extremely risky corporates and get a much higher rate of return.
Your money is not locked up. You can sell the bond and get your money back whenever you want.
Interest rate is lower than almost every bond.
Your money is locked up. If the CD is liquidated before the maturity date, you will incur an early withdrawal penalty.
You can lose all or a portion of your principal if the company goes out of business.(recoveries from default can be material).
If you sell your bond when interest rates are rising, the money you receive will be less than the principal you invested.
If you ask me, the benefits of bonds far outweigh the risks. Both investments pledge to return your principal when the investment matures. But corporate bonds pay much more income than CDs, even if you buy the safest one. And if you choose to get a higher APY by buying a risky bond, you can get information to help you evaluate that risk.
Where to Start...
We are Arthur
We're simplifying the process of purchasing a bond in order to offer investors easy access to the bond market. We're building Arthur as a community, so that together we can learn how the $50 trillion bond market can be harnessed to fund every single one of our future cash flow needs without paying fat cats for the overpriced, bond-fund package.
Buying your bonds directly is the best way
Direct investment provides certainty in holding period returns while funds are bets on interest rates and manager skill, or lack of skill.
Owning a bond directly offers you the choice and flexibility of finding something that fits your investment horizon, goals, values and social preferences without the extra management fees and other indirect costs.
Owning bonds directly allows you to get cash via the interest and coupons and cut out the middleman; there are no management fees to detract from your hard earned coupons.
Owning bonds directly means that when a bond matures, you get your money back.
Arthur will make bonds accessible to everyone.
The Founders of Arthur come from the investment management industry. We've witnessed the restricted access to direct bond investment firsthand and understand just how much money is being made on the backs of retail investors.
This will earn you a ton of extra money!
Soon, Arthur will eliminate the need to wait for bond auctions, substantial per-security minimum investment amounts, and the enormous spreads in the retail secondary market. Once we do that, there will no longer be any need for a bond fund wrapper, or manager to build a completely customized, diversified portfolio of bonds.