Should you invest money or save it? It’s an important question to ask if you’re trying to grow wealth. Investing can offer the potential for higher returns, but it can also mean taking more risks. Saving money tends to be safer, though it may limit growth. If you’re looking for an investment that’s also safe, you might consider bonds. But which is better: bonds vs. savings account?
For more help, consider working with a financial advisor.
What Are Bonds and How Do They Work?
A bond is a type of debt instrument. When you invest in a bond, you’re agreeing to allow the bond issuer to use your money for a certain time period. During that time, the bond issuer can make periodic interest payments back to you. Once the bond matures, your initial investment is returned.
Bonds can be issued by corporations or government entities to raise money. For example, cities or towns can issue municipal bonds to get the capital they need to fund public works. Other types of bonds include:
Unlike shares of stock, bonds don’t grant you any ownership stake in a company. Instead, you’re acting as the bond issuer’s lender temporarily.
A bond has a face value, which represents the amount you’ll receive once the bond matures. Face value can also be referred to as par value or nominal value. The coupon rate is the interest rate paid on the bond’s face value. Bond yield, meanwhile, represents the return on investment you receive for purchasing the bond.
The rate of return you earn on a bond and the amount of risk you take can depend on the type of bond and the credit quality of its issuer. Junk bonds, for example, carry more risk because they’re issued by companies with lower credit ratings. But in return for accepting a higher degree of risk, you may earn a higher rate of return.
What Is a Savings Account and How Does It Work?
Savings accounts are deposit accounts offered by traditional banks, online banks and credit unions. When you open a savings account, you’re not investing anything in the market. Instead, you’re keeping your money in a secure account where it can earn interest according to the rate set by the bank.
The FDIC can insure savings account deposits, so there’s virtually no risk of losing money on the off chance that your bank fails. The current FDIC coverage limit is $250,000 per depositor, per account ownership type, per financial institution. The National Credit Union Administration (NCUA) provides similar coverage for savings accounts held at member credit unions.
You don’t have to wait for a savings account to mature; you can withdraw money from it as needed. Your bank can, however, limit how often you can make withdrawals. For instance, you might be capped at six withdrawal transactions monthly. If you go over that limit, the bank might charge you a fee.
Bond vs. Savings Account: Which Is Better for Saving?
Bonds can be an attractive option if you want to invest money for fixed income. A bond can offer a predictable rate of return, without the same level of risk exposure as stocks. That doesn’t mean, however, that bonds are a risk-free investment.
Bonds are subject to a number of risks, including:
Credit risk. Credit risk or default risk is the risk that the bond issuer will default and be unable to make interest or principal payments back to investors.
Interest rate risk. When interest rates rise or fall, that can affect a bond’s value and the rate of return investors realize.
Liquidity risk. Liquidity risk refers to the likelihood of an investor being able to sell bonds to convert them to cash.
Inflation risk. When inflation rises, prices increase. That can shrink purchasing power, making higher inflation problematic for investors who are earning returns from fixed income investments.
Call risk. Some bonds are callable, meaning the bond issuer can terminate them before the maturity date. When a bond is called, that reduces the interest investors receive.
With savings accounts, you don’t have those risks. And again, if your account is held at a member FDIC bank or member NCUA credit union, you’re also insulated against the risk of institutional failure.
The trade-off, however, is that bonds can outstrip savings accounts when it comes to the level of returns they can produce. So you might be exchanging a better rate of return for increased security when choosing a savings account vs. bonds.
Using Bonds vs. Savings Accounts in Your Financial Plan
You don’t have to exclusively use bonds or a savings account to reach your financial goals. You can have both at the same time to enjoy the benefits each one offers. If you’re interested in bond investing, it helps to evaluate your goals, timeline and risk tolerance. Junk bonds, for example, may be something you want to take a pass on if you’re generally more conservative with your investments.
It’s also important to consider bond maturities and the current interest rate environment. When interest rates rise, bond prices fall and vice versa. Bonds with longer maturity terms tend to be more sensitive to interest rate fluctuations. So if rates are rising, you may want to consider shorter-term bonds to maximize returns.
Age can also play a part in determining how much of your portfolio to allocate to bonds. If you’re 30 or 40 years away from retirement, for example, financial experts typically say that you can afford to take on more risk. So you might want to limit your bond allocation to 10% of your total portfolio and devote the rest to stocks to maximize growth.
With savings accounts, your goals matter more than age or risk tolerance. For example, you might need to open a savings account to set aside money to buy a home or build your emergency fund. Your choice of bank matters for maximizing the interest rate you can earn on savings deposits while minimizing the fees you pay.
So how much should you keep in savings? If you’re saving for emergencies, three to six months’ worth of expenses is a good starting point. You might increase that to nine or 12 months if you’re worried about an unexpected illness or job loss that could hurt your ability to pay the bills.
The amount you save toward other goals can depend on the goal itself. So if you’re saving for a down payment on a home, your goal might be $20,000. Or you might hope to save $5,000 to buy new furniture. Just keep in mind that keeping too much money in savings could leave some of your cash unprotected if your balance exceeds the FDIC or NCUA coverage limits.
The Bottom Line
Bonds and savings accounts can help you achieve different things financially. When investing in bonds or opening a savings account, it’s helpful to think about what you need each one to do for you. And with bonds, it’s also important to consider the unique risks you might face when investing your money.
Consider talking to your financial advisor about how to use bonds and savings accounts as part of your financial plan.Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you’re looking for a way to save for college for your kids or grandkids, you might consider U.S. savings bonds. You can use Series EE and Series I bonds to save for college and earn a modest rate of return, with low risk. Interest from savings bonds is tax-free when the money is used to pay for qualified higher education expenses, similar to the way 529 college savings accounts work.
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