Savings bonds and certificates of deposit (CDs) are both debt securities that can be purchased commercially. Investors use both of these investment types to make income on money in a low-risk alternative to equities, real estate or other complex investment vehicles. 

The Risk vs. Return Relationship 

Both savings bonds and CDs are considered highly safe investments. However, federal savings bonds are regarded as the least-risky debt instruments because they have a credit rating of AAA and are fully backed by the federal government. This makes the risk of investing in a savings bond lower than the risk of investing in a CD.

Savings bonds pay a smaller interest rate on the invested principal than CDs to compensate for the lower risk. While the return of a savings bond is normally lower than a CD, it also provides greater security while still paying interest on a principal amount. In a period of fluctuating interest rates and oscillating commodity prices, it is safer to choose a debt investment with a AAA rating, like savings bonds. 

While savings bonds are considered to be safer, CDs are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per bank. So, if an investor is making a modest investment, it would be wise to discuss CDs and savings bonds with high credit ratings with a financial advisor prior to investing.

The Differences in Flexibility

The Federal Reserve in 2016 increased interest rates by a marginal amount for the first time in almost a decade. They are expected to raise rates until target inflation is met, which means that investors interested in a debt instrument should prepare for the likelihood of rising or fluctuating rates, and factor that into their investment strategy. 

There are two different types of government savings bonds. An EE bond is a fixed-interest bond that is guaranteed to double in face value over a 20-year period. The rate is fixed when the bond is purchased, and tax is deferred until the bond is cashed. An I bond has both a fixed and variable interest rate. The fixed rate is set when the I bond is purchased, and the variable rate is adjusted every six months based on consumer price inflation.

It often makes sense for investors to take advantage of fluctuating interest rates by purchasing I bonds. This protects them against further increases in interest rates with the variable component, and the fixed-rate component also protects against the possibility of flat or decreasing interest rates. Compare this with CDs, where the terms of maturity can be much lower, and it is clear that CDs offer greater flexibility, albeit with generally lower long-term returns. 

Time to Maturity

Savings bonds are essentially government borrowings by the United States. Common denominations range from $25 to $10,000, and an investor must wait at least six months before cashing in a savings bond. However, it's possible to hold onto a savings bond for as long as 30 years, which allows an investor to earn interest on the principal amount over the entire time period.

CDs, on the other hand, have time to maturities that generally range from one-to-five years. Once an investor purchases a CD, the principal amount is locked in for the entire life of the CD, and the financial institution issuing the CD can assess a heavy penalty for early withdrawal. After the CD's maturity is up, an investor has to shop around again for another CD with favorable rates. Some investors buy CDs every month with a strategy known as "stacking," so each month they receive a return. This clearly gives CD the upper hand, since maturation rates can fall to as low as one month. 

The Bottom Line

It is hard to choose whether a CD or savings bond is the right choice, since each individual investor will have different approaches and objectives. Long-term investors might see greater returns from savings bonds, while investors eyeing the shorter term could utilize the flexibility of CDs more effectively.