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Bonds and savings accounts are both relatively safe places to put your money and earn a return. But each has different risk and returns profiles and one may serve your needs and goals better than the other. A savings account is an interest-bearing account that provides a safe place to store money you might need in the short-term. A bond, on the other hand, is an investment that pays interest. Bonds are relatively illiquid, slightly riskier, and may provide higher returns in the longer term. If you’re considering savings accounts vs. bonds, it’s useful to learn more about each tool.
What Is a Bond?
A bond is essentially an I.O.U. that’s issued by a government, municipality, or corporation that’s looking to raise money. When you buy a bond, you are agreeing to allow the bond issuer to use your money for a certain time period. During that time, the issuer (borrower) can make periodic interest payments back to you. At the end of that set time period, the bond is said to “mature.” At this point, the issuer will pay you the bond principal and any unpaid interest that’s owed to you.In some cases, you don’t have to hold bonds until they reach maturity. Instead, you can sell them on the secondary bond market if you now longer wish to own them.Bonds are not risk free. There is always the chance that the issuer will default, and fail to pay back their debt.
Types of Bonds
There are many different types of bonds. Each has its own sellers, purposes, buyers, and levels of risk and return. Some of the main types of bonds include:
Corporate bonds These are issued by all different types of companies. They tend to be higher risk than government-backed bonds and, as a result, generally offer a higher rate of return.
Municipal bonds These are issued by cities and other local governments. They typically have lower interest rates than corporate bonds. However, the interest you earn on municipal bonds is often tax free. Municipal bonds are considered slightly higher risk than bonds issued by the federal government, since cities do sometimes default on their debt.
U.S. Treasury bonds. These are issued by the federal government and are considered among the safest investments in the world, as they are backed by the full faith and credit of the U.S. government. Because they are considered to have low default risk, they generally offer lower yields relative to other bonds.
Savings bonds Savings bonds are also issued by the Treasury Department. There are two types available for purchase — series EE and series I savings bonds — on the U.S. treasury’s website, and they are issued in low-enough amounts to make them affordable for individuals.
The way a bond works will depend on the type of bond you purchase. If you purchase a savings bond from the U.S. government, such as an EE savings bond or I savings bond, you’ll earn a fixed interest rate. With an I bond, you'll also earn an inflation-based variable rate.Savings bonds can earn interest for up to 30 years but, after five years, you can redeem the bond any time without penalty. You don’t get the interest you’ve earned until you redeem the bond. Once you buy a savings bond, you cannot sell it to someone else. The only way to cash out is to redeem the bond.Unlike savings bonds, Treasury and other types of bonds give you regular payments. In addition, you can sell these bonds to other investors without penalty if you want to cash out before the bond matures. No matter what type, bonds are considered a relatively safe type of investment, and can be used to help manage the risk profile of your investment portfolio. Investors with a high tolerance for risk might hold relatively more stocks, while investors with lower risk tolerance might hold relatively more bonds.
Pros and Cons of Bonds
Here’s a look at some of the advantages and disadvantages of investing in bonds.
Relatively safe Bond issuers promise to pay buyers back. While you aren’t guaranteed to get your money back with interest, it’s likely that you will, especially if the bond is backed by the U.S. government.
Rated based on risk level Bond issuers have credit ratings. This helps investors know exactly how much risk they will be taking on when purchasing a bond. Riskier bonds generally offer higher interest rates.
Cons
Risk of default There is always the risk that a bond issuer will default. This doesn’t mean that you’ll lose your entire principal, but it may mean you only get a portion of it back. That’s why it’s important to check bond ratings before you buy. Highly rated bonds are less likely to default.
Low liquidity Unlike the money in a savings account, you can’t easily access the money you put in a bond. In some cases, you can’t access your investment until the bond reaches maturity, which could be 10-plus years down the road.
High barrier to entry Outside of savings bonds, buying bonds generally isn’t cheap. Many bonds are sold in increments of $1,000.
Safety Savings accounts are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor per bank, so you can’t lose your money (up to the insured limit) even if the bank goes belly up. Savings accounts at credit unions are similarly insured by the National Credit Union Administration (NCUA)
Funds are easily accessible Unlike bonds, you don’t have to leave your money untouched for a certain period of time. When you’re ready to spend your savings, you can easily access your funds.
Cons
Relatively low interest rates Because savings accounts are so safe and you can ask for your money back any time, the rate tends to be low.
Monthly withdrawal limits While savings accounts are liquid, they typically come with some restrictions. Many banks will impose a fee if you exceed six withdrawals per month.
Interest is usually taxable Also, unlike some types of bonds (and tax-advantaged savings vehicles), the interest you earn on a savings account is generally taxable.
Savings Accounts vs Bonds Compared
Here’s a look at savings accounts vs bonds at a glance.
Bonds
Savings Accounts
Liquidity
Must sell a bond or hold it to maturity to access your money
Can withdraw your money when you need it, though your bank may have monthly withdrawal limits
Interest
Generally fixed
Variable
Upfront Cost
Bonds may be expensive to buy
Some savings accounts have minimum initial deposits of just $1
Risk
Bond issuers promise to repay bond principal and interest, but there is a possibility for default
Savings accounts are insured up to $250,000 by the FDIC or NCUA
Provider
A corporation or a government entity
A bank or credit union
Who Does a Savings Bond Make Sense for?
Whether or not a savings bond makes sense for you largely depends on when you’ll need to access your money. If you don’t think you’ll need access to your cash for a few years, investing in a savings bond (such as a Series I bond) might make sense, since these bonds tend to offer higher interest rates than traditional savings accounts and are relatively low risk.
Using a Mixture of Savings Vehicles
It can be smart to use a mix of savings vehicles as part of your overall savings strategy. Since you can’t lose your money in a savings account (up to $250,000), these accounts work well for storing your emergency funds, as well as any money you plan to use in the next few months or years.If you already have a solid emergency fund and have extra funds you don’t need to touch for at least a year or two, you may want to consider investing in bonds, since they can offer a higher return than a regular savings account. Just keep in mind that you will face some market risk, and you won't be able to access your money as readily.
The Takeaway
Bonds and savings accounts are two tools that help you build wealth over time. Savings bonds generally provide a higher return than a typical savings account and are relatively low risk, but don’t offer as much liquidity and flexibility.For money you want to be able to tap in the near-term, consider opening a savings account that pays a competitive APY and has low (or no) fees, such as a high-yield savings account at an online bank. If you’re not sure where to start your search, Lantern by SoFi can help. With our online banking marketplace, it’s easy to compare high-yield savings accounts based on APY, fees, and balance minimums.Lantern can help you compare online savings accounts and find today’s best rate.
Frequently Asked Questions
Are bonds better than savings accounts?
What is the difference between bonds and savings accounts?
Is there a downside to bonds?
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About the Author
Austin Kilham
Austin Kilham is a writer and journalist based in Los Angeles. He focuses on personal finance, retirement, business, and health care with an eye toward helping others understand complex topics.
