Bonds vs. CDs

by Dual Income No Kids on March 1, 2010 · 0 comments

Hello Folks,

Here is a topic that you don’t see covered much in personal finance literature these days. It tends to come up more when you’ve gotten out of debt and are looking at low risk ways to hold on your cash while still keeping it readily available. So, provided that you have $1,000 to $5,000 you may be wondering whether you should buy CDs or Bonds?

A few points to consider:

Historically CDs are the investment of choice for many. Usually CD rates are higher than interest paid on savings accounts and unlike bonds your principal doesn’t change in value. This has made them historically popular.

But, compared to bonds, CDs do have some drawbacks.

First, CDs often penalize you if you take the money out before the deposit is mature. Unlike CDs, a no load bond fund or direct investments in bonds can be relatively quickly converted to cash – you don’t have to wait around for the CD to mature. In addition many CDs charge you 3 to 6 months interest as an early redemption fee. On the other hand, bond funds or direct ownership of bonds tends to be less expensive to redeem. For example selling bonds or a bond fund can cost between 10 and 50 dollars. Cost savings tend to be greater when you have more invested, so generally bonds give you more flexibility in buying and selling than CDs.

Second, CDs are generally taxable. On the other hand, bonds come in different flavors. They can be tax free (if they are federal and/or state) or taxable.

Third, more importantly, bonds tend to pay a couple of points more in interest than CDs.

Fourth, ss a final note, if you’re going to be buying either bonds or CDs you really should consider diversifying your holdings. For example if you own CD be sure to ladder them by buying CD with different maturity dates across different institutions. If you are buying bonds, be sure to consider a properly diversified bond fund, not just individual bonds.

Happy Shopping!

James

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