Investing in Bonds For Dummies
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As predictable as the Arizona sunrise, CDs, like zero-coupon bonds, offer your principal back with interest after a specified time frame (usually in increments of three months) for up to five years in the future. Like savings bank accounts, CDs are almost all guaranteed by the Federal Deposit Insurance Corporation (FDIC), a government-sponsored agency, for amounts up to $250,000.

Interest rates offered tend to increase with the amount of time you're willing to tie your money up. (If the bank will give you, say, 1.5 percent interest for six months, you can often get 1.75 percent for 12 months.) Take your money out before the maturity of the CD, and you pay a fine, the severity of which depends on the particular issuer.

Because nearly all CDs are federally insured, the security of your principal is on par with Treasury bonds. Interest rates vary and may be higher or lower than you can get on a Treasury bond of the same maturity. (Check Bankrate and your local newspaper for the highest CD rates available.)

FDIC-insured Internet banking accounts, which tend to pay higher rates of interest than the corner bank, are also often on a par with one-year to two-year CDs. Often the three investments — CDs, short-term Treasuries, and Internet banking accounts — hug very closely to the same (modest) interest rate. If all three are equal, the CD, a favorite with retirees everywhere, should be your last choice. Here are two key reasons:

  • The CD requires you to tie your money up; the FDIC-insured Internet bank account does not.

  • The CD, as well as the bank account, generates fully taxable income; the Treasury bond or bond fund income is federally taxable but exempt from state tax.

Even though there can be blips in time when CDs are great deals, by and large, CDs are vastly oversold. If you're going to settle for a modest interest rate, you generally don't need to have your money be held captive. Some banks of late have been offering more flexible step-up CDs that allow for interest rates to float upward; these are worth some consideration if the initial rate is competitive.

Compared to bonds: Most bonds provide higher long-term returns than CDs and tend to be more liquid (meaning you can cash out easier). However, only Treasury bonds carry the same (or very similar) U.S. government guarantee that a CD has.

About This Article

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About the book author:

Russell Wild is a NAPFA certified financial advisor and principal of Global Portfolios, an investment advisory firm based in Allentown, PA that works with clients of both substantial and modest means. He has written two dozen books and numerous articles on financial matters.

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