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Are CDs a Better Idea than Bonds?

Many investment portfolios have a targeted mix of stocks and bonds (or their related funds). Few think about the role that Certificates of Deposit (CD) may play. Most of the time, CDs are used when checking and savings balances have grown to excessive levels, above and beyond the need for liquid “rainy day” funds.

To be sure, the interest rate that you’ll get on a CD is typically lower than the yields offered by bonds. Yet thanks to ongoing and unusual dynamics in the bond market, interest rates on these two types of investment vehicles have flipped.

A recent article in Barron’s suggests that one-year CDs are now yielding close to 2%, higher than the yield on a one-year bond, which stands at around 1.5% (at the time this article was written). 

And it’s not just the smaller yields of bonds that should concern you. When it comes to CDs, what you see is what you get. The promised interest rate will be earned when it matures. But bond funds bring a specific element of risk: When interest rates rise, bond prices fall. So that bond fund you own may lose some value, taking a bite of the yields you planned to earn.

As an example, if interest rates rose by one percentage point, and the bond fund owned bonds that matured, on average, in three years, the bond fund would lose 3% of it’s value. 

You’ll rarely find an opportunity to own an investment that carries lesser risk and greater reward, a sis the case with CDs right now. 

To get the best CD yields, you may need to shop online as local bank branches may not offer the market-leading yields (though it pays to inquire at your local bank branch and compare). 

Discount brokers such as Fidelity Investments, Vanguard, TD Ameritrade and Charles Schwab also offer the ability to buy CDs within brokerage and retirement accounts. So should you dump your bond funds and load up on CDs? Well, that depends on your investing time frames. Funds that focus on longer-term bonds will always offer better yields than CDs. (Though as noted, such bond funds are also subject to the risk that they will lose value if rates rise).

To help decide, reach out to your local fee-only financial planner.