Key Takeaways:
At some point in time, every investor will find themselves asking one simple question: Which investment is the best? Each investment opportunity will come with unique benefits and tradeoffs, suggesting that the best investment strategy is actually to pursue multiple opportunities. Diversification has proven incredibly useful for investors in every field. Please keep reading for our in-depth look at CDs vs. bonds, and learn how each of these strategies could help boost your investment portfolio.
What Are Bonds?
Bonds are notes issued by governments or corporations allowing investors to contribute financing, hoping that they will be paid back in the future with interest. Bonds will have varying timeframes and interest rates depending on the borrower, though each of these factors will be agreed upon beforehand. This means investors can predict the exact profits they will earn if the bond is held to maturity. As a whole, bonds are thought of as a relatively low-risk investment; while profits are impacted by inflation, they do not fluctuate based on interest rates as other investments can.
Types Of Bonds
The term “bonds” doesn’t refer to a single type of investment but rather an entire umbrella of investments. If for nothing else, there are several types of bonds, each of which has become with different industries and government entities. For a better idea of what types of bonds investors may choose from, take a look at the comprehensive list below:
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Corporate Bonds: Corporate bonds are debt instruments issued by businesses and corporations. Companies with the ability to do so will issue corporate bonds to pay for many things, like scaling their business or funding research and development. Corporate bonds typically boast higher yields than other types of bonds, but the interest is taxable.
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Municipal Bonds: Cities, towns, and states will issue municipal bonds to raise money for public initiatives. Schools, roads, and hospitals can all be funded and paid for by municipal bonds. Unlike the previously mentioned corporate bonds, the interest made from holding a municipal bond isn’t taxed.
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General Obligation (Municipal Bonds): Municipalities use general obligation bonds to pay for projects which don’t generate income on their own. As a result, the city, town, or state needs to develop an alternative way to pay the bondholder, which is why they issue general obligation bonds.
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Revenue (Municipal bonds): Municipalities across the country issue general obligation bonds to fund projects which generate income. For example, to build a toll road, a town would issue a revenue bond to generate capital. As a result, the revenue generated from the toll road will be used to pay the bondholders.
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Treasury Bonds: Otherwise known as T-bonds, treasury bonds are always issued by the U.S. government. Since the government backs them, treasury bonds coincide with the least amount of risk. However, the lack of risk also means the coupon rate on treasury bonds is much lower.
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Savings Bonds: As fixed-income instruments issued by the U.S. Department of the Treasury, savings bonds help pay for the government’s borrowing needs. Again, bonds backed by the U.S. government are generally the safest, but the yields are slightly lower than those associated with other bonds.
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What Are CDs?
Certificates of deposit (CDs) are a type of bank account with fixed interest rates and a set withdrawal date. Certificates of deposit can be thought of as a mix between a savings account and a bond. Individuals invest in a CD and earn interest over time, although they cannot access the money until a predetermined date in the future. They are issued by banks and financial institutions and are insured by the FDIC. Term lengths will depend on the CD but typically range from one to five years.
Types Of CDs
Not unlike their bond counterparts, CDs are not limited to a single type. Instead, CDs can fall under several categories, not the least of which include:
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Fixed-interest Rate CDs: Once an account is opened, fixed-interest rate CDs award their holders with a predetermined interest rate.
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Variable-interest Rate CDs: These types of CDs, as their names suggest, will increase or lower their interest rates based on the current market benchmark. As a result, Variable-interest Rate CDs have both more upside and more downside.
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Jumbo CDs: These types of CDs get their name from the minimum investment amount. While minimums will vary from bank to bank, Jumbo CDs will require a much higher initial investment. In return, certificate holders are awarded a higher yield.
CDs Vs Bonds: Risks & Returns
Bonds and CDs are similar in nature, with both representing the chance to earn long-term income through debt securities. By looking at the relationship between risk and returns, investors may find a few differences in CDs vs. bonds.
Overall, bonds present a lower risk than CDs. This is because the federal government often backs bonds. While the FDIC insures cDs for amounts up to $250,000 per bank, the overall risk of investing in CDs is still slightly higher than bonds.
The low-risk nature of these investments does not come without tradeoffs. Both CDs and bonds are lower performing than other investment opportunities, such as real estate. This is because CDs and bonds only generate income through interest, with some profits undermined by inflation. When looking directly at CDs vs. bonds, investors may notice CDs yield slightly higher returns due to higher interest rates.
Because the CDs vs. bonds debate is so close, and each asset has pros and cons, investors may find it helpful to examine the time it takes for each investment to mature. You may find long-term options offer higher returns, though there may be less flexibility involved. When choosing between bonds vs. CDs 2018, consider the time frame, risk, and return potential of the options available to identify the right opportunity.
Bonds Vs Real Estate
When looking at CDs vs. bonds, investors may find they do not yield high enough returns to make a strong investment portfolio. For those hoping to realize larger profit margins, it is helpful to consider other investments’ performance, such as real estate.
Bonds and real estate are among the most well-known investment strategies, though they have several differences. While bonds generate their income through interest, real estate can represent the opportunity to generate steady cash flow through rental income while simultaneously building equity in a physical asset. Real estate often outperforms bonds, though the returns do come with greater risk.
These differences in risk and return are important to consider, though investors should also pay careful attention to the ways other factors can impact these investments; particularly, how inflation and taxes can influence each opportunity’s success.
Taxes
Bonds are not awarded many tax benefits and are often not even taxed at the federal level. Investors must pay income and/or capital gains taxes on the revenue generated from bonds, no matter how small their returns. In contrast, real estate offers several tax benefits, including the opportunity for multiple tax deductions. It is well known that real estate investors can benefit from the depreciation deduction, which provides investors with a tax break for the wear and tear incurred on rental properties. Read our guide on real estate investing tax benefits to learn more.
Inflation
Inflation is another factor that impacts bonds and real estate differently. Bonds pay a fixed interest rate over time, leading them to be significantly affected by inflation. On the other hand, real estate often benefits from inflation as a result of increased rent prices and property value. While the value of bonds is predetermined, real estate investors stand to benefit from property appreciation and rental increases due to inflation. Check out these benefits of investing in real estate to learn more.
CDs Vs Real Estate
When comparing CDs vs. real estate, investors may notice several of the same tradeoffs regarding bonds vs. real estate. Real estate will yield higher returns but with more risk than CDs. Real estate will also benefit from tax policies and inflation more so than CDs.
Many investors may find CDs to be an attractive investment because of their passive nature. However, real estate can also represent the chance to earn passive income in the right situations. Real estate investors can either work with a business partner or property manager to handle the property’s day-to-day operations. By doing so, real estate investors can simultaneously benefit from the passive nature of rental properties and enjoy attractive profit margins.
As a whole, CDs vs. real estate will lead investors to many of the same conclusions when comparing bonds and real estate. There will be tradeoffs and benefits to consider with nearly every investment vehicle, particularly between two very different opportunities like CDs and real estate.
Summary
As an investor, it is important not to question which investment is the best but instead to look at how different investment types can contribute to your portfolio’s overall success. Investors who opt for multiple investment types minimize risk and increase their revenue potential. When it comes to CDs vs. bonds, determine how each option can fit best into your existing financial profile.
Have you ever worked with bonds or CDs? Share your experience in the comments below:
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