Differences Between CD and Bonds – A Secure-Investment Showdown

The relationship between average CD rates and U.S. government bond yields these days is that at some maturities, CDs offer twice as much interest as bonds.
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By Richard Barrington

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The search for safe income is not very rewarding these days — both bank rates and bond yields are at or near record lows. That makes it all the more necessary for consumers to scrounge for every point of yield they can find. One trick for choosing between deposit accounts and bonds is knowing that the right answer might vary depending on how long you are willing to lock up your money.

Among deposit accounts, certificates of deposit (CDs) particularly lend themselves to comparison with bonds because they have a designated maturity date. What’s striking about the relationship between average CD rates and U.S. government bond yields these days is that at some maturities, CDs offer twice as much interest as bonds, but at other maturities, the relationship is reversed.

Essential differences between CDs and bonds

Before looking at how the numbers stack up these days, it is worth reviewing some of the essential differences between CDs and Treasury bonds:

  1. Cost of access. CDs are typically very easy to access, with no fees and usually fairly low minimums. Buying Treasuries is likely to involve some trading costs if you do it directly, or management fees if you buy them via a mutual fund.
  2. Reaction to interest rate changes. The value of Treasury securities moves up and down due to changes in market interest rates, while your CD will not change in value other than with the accumulation of interest. However, if you hold your Treasury securities to maturity, the interim fluctuations won’t matter much because you will get the face value of the bond at the maturity date.
  3. U.S. government guarantee. Both Treasuries and deposit accounts are backed by the U.S. government, but with deposit accounts, the guarantee is limited to $250,000.
  4. Market inefficiency. On any given day, Treasuries will cost pretty much the same no matter where you buy them, while there are significant differences in CD rates from one bank to another, which makes shopping around worthwhile.

In many cases, one or more of the above may be the deciding factor in choosing between CDs and Treasuries. Otherwise, the decision may come down to a yield comparison.

CD rates vs. bond yields

So which has the advantage — Treasuries or CDs? It depends very much on the length of time.

As of the beginning of June, one-month CDs and Treasuries had similar yields, with the average CD offering 0.05 percent and the average Treasury yielding 0.04 percent. As you start to move a little further out though, CDs begin to show an advantage. Three-month, six-month, and one-year CDs were all offering exactly twice the yield of their U.S. Treasury counterparts. For example, one-year CDs were offering 0.20 percent while the yield on one-year Treasuries was 0.10 percent.

After one year though, the advantage flips to Treasuries. Two-year Treasuries are yielding 0.38 percent, compared to 0.33 percent for the average two-year CD. The advantage for Treasuries is a little wider for three-year maturity dates, and by the five-year mark, Treasury yields are roughly double CD yields, with 1.53 percent for Treasuries and 0.72 percent for the average five-year CD.

All things considered then, if you are investing for one year or less, you will probably do better with an average CD than a Treasury bond. For longer-term commitments, it might be worth looking at Treasuries instead.

However, if you’re willing to shop around, you’re likely to find CD rates that outpace these national averages and maybe even the yields on Treasuries of the same length. Just be sure to review all of the terms on any prospective account — including the early withdrawal penalty, which could become important if rates rise before your maturity date — before you make your deposit.

Frequently Asked Questions

Q: I just inherited about $10,000. What would be the wisest thing to do — invest in an I-Bond or a certificate of deposit?

A: Assuming your goals are security and income, Series I Savings Bonds (I-Bonds) and certificates of deposit (CDs) make for an interesting comparison, especially given the unusually low inflation environment of recent years.

I-Bonds are issued by the U.S. Treasury and pay an interest rate that is made up of a fixed rate plus a variable rate based on the rate of inflation over the prior six months. For the most recently issued I-Bonds, that fixed rate was zero, making these instruments purely an inflation hedge. You can expect your rate of interest to keep up with inflation, no more and no less.

An important caveat about an inflation hedge is that inflation can differ from one person to the next. I-Bond rates are determined by changes in the Consumer Price Index (CPI), which measures a broadly based basket of typical consumer goods. However, if your expenses are weighted heavily toward a particular area — for example, if you face significant health care expenses, or plan on going to college — the changes in your expenses may not match changes in the CPI, and thus I-Bonds cannot be guaranteed to keep up with those expenses.

CD rates are generally fixed for the full term of the CD, and are based on prevailing market interest rates at the time of issuance. Market rates include an implicit inflation assumption, but they are not specifically geared to the inflation rate nor do they change as the inflation rate changes.

CD terms can range from as little as one month to multiple years. I-Bonds are issued for 30-year terms, but are redeemable after one year, and without penalty for five years. The latter restriction makes five-year CDs a good comparison for I-Bonds. Currently, I-Bonds are paying a 1.48 percent annual interest rate. Five-year CDs are paying an average of just 0.79 percent, though you should be able to do better if you shop around for the best CD rates. As of this writing, several banks are offering rates of 2 percent or more.

Where the recent inflation environment makes things more interesting is that the change in the CPI has turned sharply negative since the last time the I-Bond rate reset. That raises the possibility that the overall interest rate on I-Bonds could turn negative the next time it resets, on May 1, 2015.

In that case, you are likely to find the best yield for the near-term by shopping for the best CD rates. However, if you think that inflation will soon return to positive territory and start rising sharply, I-Bonds may be worth a closer look, since CD rates won’t be able to adjust quickly.

About Author
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Richard Barrington
Richard Barrington has been a Senior Financial Analyst for MoneyRates. He has appeared on Fox Business News and NPR, and has been quoted by the Wall Street Journal, the New York Times, USA Today, CNBC and many other publications. Richard has over 30 years of experience in financial services. He has earned the Chartered Financial Analyst (CFA) designation from the Association of Investment Management and Research (now the “CFA Institute”).