You have the choice of being the bank or the customer when choosing between bonds or certificates of deposits. With a bond, you are the lender. With a bond of certificate, also known as a CD, you are the customer. Either way, these are two different means to grow your savings and your tolerance for risk is the best indicator of which role you should play.
Bonds are IOUs. They are offered by municipalities, states, corporations or the federal government as a means to get funds from the public. And like any loan, there’s interest involved. The issuer of the bond will pay you back the principal plus the interest they are obligated to pay based on their ability to pay the money back. Also like bonds, they have maturity dates.
Certificates of Deposit
These savings vehicles are sold by banks. They allow you to park your money for a year or up to 10 years while it accumulates interest. The rate of interest is usually pretty low. In fact, according to Bankrate.com the highest yield on a CD as of mid-March 2013 was 1.25 percent. The reason for the paltry returns has to do with the safety of CDs. Unlike bonds, the Federal Deposit Insurance Corporation protects the investment up to $250,000. So even if the bank that sold the CD goes belly up, the investment is safe. CDs are also callable, meaning a bank can call the CD back after a certain time and reissue the CD at a lower rate should the rates decrease.
Types of Bonds
The safest of the bonds on the market are U.S. Treasury Bonds. Because the government has never defaulted on a loan, they are of high quality and thus have a lower interest rate. As of mid-March 2013, the rate of the 10-year Treasury bond is hovering around 2 percent. Municipal and state government bonds have a little more risk tagged to them, some more than others. The financial wherewithal of these states or municipalities determines rate of interest. Municipal bonds coming from a growing town with a diverse economy will have a lower interest rate than a poorer town with a shrinking population. Each will be given a rating by a company like Moody’s Investment Services, Inc. on their ability to pay off loans. Corporate bonds are loans to larger companies with rates of return that fluctuate like those of any other bond type. The more financially sound the company, the safer the corporate bond.
Types of Certificates of Deposit
A traditional CD is just that, traditional. You give a bank or financial institution your money and it grows at a certain rate over a period of time. A bump-up CD does pretty much the same thing as a traditional bond but should interest rates rise in six months on a two-year CD, for instance, so does the interest rate of your CD. The downside is that the initial rate is usually lower than a traditional CD and banks normally only allow one bump-up. Other bond options include: • liquid CDs, which allow a customer withdrew money at any time; • zero-coupon CDs, which allow customers to buy CDs at a discount but the buyer will only get the principal and not the interest; and • brokerage CDs, which are CDs sold by a brokerage companies on behalf of banks.
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