There is a fair amount of overlap between certificates of deposit (CDs) and bonds: They are both fixed-income securities that you generally hold onto until maturity. Simply put, you invest your money in a CD or bond for a set period, and you know exactly what you will receive when that time is up.
They are both debt-based, meaning that you are the creditor, which is no different than having a friend ask for $10 today and give you an IOU promising to pay $11 next week. The interest ($1) is collected for the same reason that banks charge interest on loans: to compensate you for delaying your ability to make use of the money. You can’t spend that $10 when you don’t have it.
- Certificates of deposit (CDs) and bonds are both debt-based, fixed-income securities that you hold until their maturity dates.
- Bonds are riskier and so tend to pay higher interest rates than CDs.
- The issuers of bonds are primarily companies trying to raise funds for operations, product development, or the opportunity to expand by buying another company.
- CDs are short-term investment vehicles, while bonds are long-term ones.
- Banks and credit unions are the primary issuers of CDs.
Bonds vs. CDs
Now that we've clarified why bonds and CDs fit under the same broad category, here is how they differ.
In the case of bonds, the issuer is usually a company trying to raise funds for operations, the development of new products, or the opportunity to take over another company. Investment-grade bonds have a very low default risk (the chance that your friend will take your $10 dollars and never come back), but it can still happen.
The issuer of CDs is usually a bank or credit union because CDs are not issued with the same motives that underlie bonds. A CD is similar to a savings account—basically a place to hold your money until you want to do something else with it.
Because bonds issued by a company are riskier, they offer a more favorable return to the people who buy them. The return on CDs, though typically less than bonds, is a little better than a savings account.
People often refer to any fixed-income security as a bond, but that is technically incorrect; bonds generally mature after 10 or more years, while CDs and other fixed-income securities tend to have shorter maturities.
Time to Maturity
This is the sticky part—but also the most significant point. Bonds are longer-term investments, generally maturing after more than 10 years. By contrast, CDs mature in as little as one month and in as many as five years (or even, less commonly, 10 years). The complication we run into now is that there are further distinctions or categories within the world of fixed-income debt securities, and they overlap everywhere.
The loose categorization is as follows:
- Treasury bills (T-bills) generally mature in less than one year.
- Notes generally mature between one and 10 years.
- Bonds generally mature after a decade or more.
In other words, while a bond is technically a fixed-income security with a maturity of 10 years or more, people often use the term "bond" to refer to fixed-income securities in general—even for those securities with a maturity of less than 10 years.
The Bottom Line
The difference in time commitment for bonds and CDs is best expressed in terms of the investor’s motives. As previously mentioned, CDs are generally considered short-term, low-risk, interest-paying storage for capital until a more profitable investment can be found. Bonds are considered long-term vehicles for guaranteeing a profit and, perhaps, offsetting some of the risks an investor may face in higher-yield investments, such as equities.