Bonds and savings accounts both can be effective means of accumulating wealth. The big difference between bonds and savings accounts is that investors can sell their bonds to other investors before the bonds reach their maturity date. People who invest in savings accounts don't have this option. Bank savings accounts cannot be sold or traded to other investors. It comes down to the fact that bonds are negotiable IOUs. Savings accounts are not.
While bonds and savings accounts are fundamentally distinct, they do share some key similarities. When an investor deposits money in a savings account the investor is essentially loaning money to the bank, and the bank pays interest to the investor on her deposit. The same thing happens with bonds. An investor who buys bonds issued by a company or government entity is loaning money to the issuer in return for interest payments. When a bond reaches its maturity date, the investor receives his initial investment back just as he would if he had withdrawn it from a savings account.
Money invested in savings accounts maintains a steady value, which does not go down unless the owner makes withdrawals from the account. Bonds rarely stay at their par value -- $1,000 -- in the secondary market. At certain times during the life of a bond, it may trade for more or less than $1,000 in value. Bond prices fluctuate up and down based on factors such as interest rate changes, the creditworthiness of the issuer and the length of time to maturity.
Savings accounts up to $250,000 are insured by the Federal Deposit Insurance Corp. in the event of a bank going out of business. But bond investors can run the risk of losing money if a bond issuer defaults. Bonds issued by the federal government are considered risk-free because U.S. Treasury will always make its interest and principal payments to bondholders. Bonds issued by state and local governments, however, depend on the financial health of the issuer. Bonds issued by corporations run the risk of default if the company falls on hard times.
Savings account investors can leave their money in the bank for as long as they like and withdraw it at any time that is convenient. Bond investors are faced with call risk. This means that even though an investor may have purchased a bond paying 6 percent for 10 years, the corporation or municipality may repurchase the bonds from its investors before the maturity date. This is likely to happen if market interest rates drop below the rate the bond is paying. When an issuer calls a bond, it pays off the old bonds it sold to investors and reissues new bonds at a lower rate. This is bad for bond investors because they lose the higher rate they were receiving, but good for bond issuers because they end up paying less interest to investors.
- Jupiterimages/Photos.com/Getty Images
- Hard Call vs. Soft Call Protection
- Bonds vs. Equities in a Portfolio
- The Disadvantages of Bonds Compared to Stocks
- Relationship Between Bond Price & Yield to Maturity
- Money Market Vs. Interest Rates
- Factors Affecting Bond Yields
- Bonds vs. CDs for Long-Term Savings
- Refunding Bonds vs. Refinancing Bonds