However, you typically won’t earn as much interest as you would with a bond. A bond is an investment that pays interest income, usually at a fixed rate. You may also be able to make money from a bond by selling it for more than you bought it for before it matures.
What Are the Differences Between a Bond and a Savings Account?
In order for a company or government to issue a bond, it has to agree to pay you a specific interest rate for the life of the bond. The rate is often fixed, which means it won’t be as volatile as other investments. Each month, the interest gets calculated. That amount then is paid out, typically twice a year or semi-annually. Many investors use bond interest to live on, although you can reinvest the interest and let it grow with the bond. With savings accounts, the interest rate can (and often does) change over time because the accounts typically use variable interest rates that depend on the rates set by the Federal Reserve. Additionally, the amount of interest you’ll earn on your savings account usually is much lower than what you’d get from a bond.
Issuer or Provider
You can buy different types of bonds from various entities, such as the government or corporations. Corporations sell corporate bonds. If you want the security of a government-backed bond, several types are available, including:
U.S. Treasury bonds: These are long-term bonds (30-year maturity) that you can purchase directly from the government or in the secondary market. U.S. savings bonds: These include Series EE and Series I bonds that typically pay interest for a 30-year period. You can’t buy them in the secondary market. Treasury Inflation-Protected Securities (TIPS): These bonds help protect your investment from rising inflation. Municipal bonds: These usually are issued by state or local governments. Types of municipal bonds include general obligation bonds (not backed by assets, just faith in the issuer); revenue bonds (backed by revenue from a specific project); and conduit bonds (bonds issued by a government on behalf of a private organization such as a nonprofit). Research what bond options are available when you’re ready to purchase, and pick one that you think is a good fit for your goals.
If you want to open a savings account, find a bank or credit union that suits you. Each has different rates, terms, and conditions, so shop around to find a savings institution that meets your needs.
Liquidity
Once you’ve purchased a bond or deposited your money into a savings account, you might want to access the funds in the future. With a bond, that isn’t always easy to do, and that depends on the kind of bond you own. One of the big liquidity risks of owning corporate bonds is that you may not be able to find a buyer to sell the bond to when you want. If the bond is not traded on the secondary market, you might have to go through a broker to find a buyer, which might not fetch you the best price. While it may be easier to find a market for a government-issued bond, depending on the type of bond, there may be multiple rules that could pose a challenge. For example, you may have to pay a fee or a penalty if you sell the bond before it matures. You might not be able to cash a bond for at least one year. Then, if you cash it in early, you could lose money. For example, if you cash in a Treasury EE or E bond before you’ve owned it for five years, you’ll lose three months of interest. When you sell your bond, if bond prices have fallen, you might not get the full value of your investment back. It depends on market conditions at the time of the sale. With a savings account, you can usually access your money at any time. If an emergency arises, you can make a withdrawal and get the cash. You may also be required to have a certain amount of money in your savings account at any given time. Some banks impose fees for letting your balance drop below a minimum amount.
Taxes
Interest income from both savings accounts and bonds (except tax-free bonds) is subject to federal income tax. In addition, you will need to pay capital gains tax if you sell a bond early and make a profit, even if it’s a tax-exempt bond. If you keep the bond until it matures, there won’t be any capital gains to tax.
Risks
While both bonds and savings accounts are considered safe homes for your funds, they each have risks. Since the government issues them, Treasury and municipal bonds are often considered to be some of the safest investments. This means there’s a very low chance of losing money if you invest in them. However, other bond issuers may not have the same level of protection. Corporate borrowers could default. Bonds also have market risk, which means that if interest rates go up, the price of your bond will usually go down. That’s because new bonds have a higher interest rate than those currently on the market. Bond prices can also fall if the borrower’s credit rating drops. A savings account is very low risk. If you open your account in an FDIC-insured bank or NCUA-insured credit union, you’re guaranteed to get back at least $250,000 of your balance if the institution fails. However, there’s still a risk to consider. Your savings account interest rate may not be enough to offset inflation, and you’ll lose spending power by leaving your money sitting around in the account.
Which Is Right for You?
A savings account is a good option if you’re looking for a safe place to keep your money. The returns will probably not be as high as with a bond, but your money is easily accessible if you need it. If you’re planning for the long term and won’t need access to your money for at least a year, a bond may be a good choice. Just remember that you may face some market risk, and you won’t be able to access your money as readily.
The Bottom Line
Before you start investing in bonds, it makes sense to have a savings account you can access in an emergency. However, you don’t have to leave all your money in a bank; you can have both types of accounts. Owning multiple accounts can help you reap the benefits of both while minimizing risks.
