When you want to save money for the long term, you can’t stuff your money away where it won’t earn interest. Inflation will make your money worth less over time. That’s because a dollar buys fewer products or services as prices go up. You need interest to help you keep up with inflation. To earn interest, you may consider CDs or bonds. Each of them will pay you, but each also has risks.
Advantages of Bonds
Bonds typically pay a better interest rate than CDs. Government bonds offer the lowest return in the bond family, but even their rates are higher than CDs. Corporate bonds normally yield the highest returns. With any type of bond, you can expect better interest than what a bank will pay you. In addition, you have the advantage of being able to sell bonds if you need cash.
Disadvantages of Bonds
Corporate bonds carry much higher risk than CDs. The risk is that the company could default on its payments or it could fail altogether and your bond could become worthless. Although not insured, government bonds are safer, and U.S. government bonds are backed by the full faith and credit of the government. Any type of bond can lose value if interest rates rise. Assume, for example, that you own a bond paying 3 percent and interest rates rise to 4 percent. You want to sell your bond, but would-be buyers could get a better rate by buying a new bond. To sell your bond, you might have to offer a discount.
Advantages of CDs
CDs pay a steady interest rate for the duration of the CD. Because the Federal Deposit Insurance Corporation considers a CD a bank deposit, your money in this investment is insured up to $250,000. You must leave your money in the CD for a set term. This lets your investment grow. CDs do not go down in value, so you will not lose your original investment.
Disadvantages of CDs
If you withdraw your money before the CD matures, you must pay a penalty. This can wipe out any gain in interest. CDs do not pay as high an interest rate as five-year bonds typically do. You are sacrificing interest in exchange for safety. If interest rates go up, your CD rate will not go up with them. You will have to wait until your CD matures to buy a new one at a better rate.
Kevin Johnston writes for Ameriprise Financial, the Rutgers University MBA Program and Evan Carmichael. He has written about business, marketing, finance, sales and investing for publications such as "The New York Daily News," "Business Age" and "Nation's Business." He is an instructional designer with credits for companies such as ADP, Standard and Poor's and Bank of America.