Savings Accounts vs. Bonds: What's the Difference?
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Savings accounts and bonds are two different ways to you can make your money work for you. Both are very safe places to keep your money, but each has different potential returns and characteristics. Savings accounts are well suited for money that you may need to access quickly. They’re also good for money you cannot afford to lose. Bonds are best for money that you want to keep safe, but won’t need on a moment’s notice.
Quick answer: Savings accounts are offered through banks, who usually pays interest on your deposits. Money in savings accounts are easily withdrawn at any time. Essentially, bonds are loans to the government and corporations (usually). You'll earn interest on the bonds, but they may have rules as to when you can redeem them. Generally, savings accounts are ideal for low-risk, short-term savings and bonds are ideal for low-risk, long-term savings.
In this article, we’ll go over the pros and cons of both savings accounts and bonds to help you decide where they fit in your savings strategy.
Savings Accounts Are Easily Accessible
A savings account is a type of deposit account that is offered by nearly every bank. Next to the checking account it’s the most popular bank account available. It’s also the type of account that your parents probably opened for you if they helped you start a bank account as a child.
Earn interest on your money
Banks offer interest on the money you deposit in a savings account. Because savings accounts are so safe and you can ask for your money back any time, the rate tends to be low. Still, the interest gives you a way to make some money from your money. The interest you can earn from money in a savings account is expressed as a percentage per year. For example, a savings account with a 1.00% APY will pay you $10 per $1,000 in the account each year. Interest is paid every month, so you can still earn interest even if you need to make a withdrawal.
Here are online savings accounts with the high APY rates:
Banks offer interest on savings accounts to encourage people to keep money in the account. That’s because deposits are how banks can offer loans to other people. Your bank will take the money you’ve deposited and pool it with everyone else’s deposits. Then, your bank will offer loans to other customers. Mortgages, credit cards, and car loans are all funded by money kept in savings accounts.
Since the borrowers pay a higher interest rate to the bank than the bank pays to you, the bank makes money and keeps operating. By law, the bank needs to keep a certain amount of money on hand, depending on how much money its customers have deposited. That means you don’t need to worry about not being able to withdraw your money because the bank has loaned it all away.
Insurance on deposits
The idea behind a savings account is that it serves as a safe place for you to keep money you don’t want to keep as cash. You deposit the money in your savings account and the bank promises to give it back to you when you ask. Savings accounts in the United States are completely safe, you can never lose the money you have in one.
This is thanks to the Federal Deposit Insurance Corporation (FDIC). The FDIC insures all savings accounts up to $250,000. Even if the bank your account is at closes, you will get your money back.
Savings accounts are completely safe and easy to withdraw money from. That makes them perfect for saving money you cannot afford to lose. They’re also ideal for holding money you may need without warning, like an emergency fund.
Bonds Are Designed to Be Long-Term Investments
Bonds are a type of investment that you can purchase. Bonds have a face value, which is usually the amount you must pay to purchase the bond. Bonds also have an interest rate, which is the return you’ll earn from the bond each year. To put it simply, if you buy a bond from someone, you are loaning money to them at the specified interest rate. The bond serves as the vehicle by which you can prove that you are owed payments. So long as the bond issuer does not go bankrupt, you’ll know exactly how much money you’ll make if you keep the bond to maturity.
Where to buy bonds
There is a wide variety of bonds that you can purchase, such as government bonds, corporate bonds, and municipal bonds. Each has different risk factors and expected rates of return.
The safest bonds in the world are bonds issued by the United States government. When you buy a US government bond, you are making a loan to the world’s largest economy. Because of the United States’ place in the world economy, US bonds are considered completely safe. If the US is ever unable to make payments on its debts, there will be bigger problems to worry about than losing your investment.
You can purchase US bonds directly from the government through Treasury Direct. Treasury Direct is a federal website that lets you invest in savings bonds, as well as Treasury bonds, notes, and bills. Savings bonds are the best-known type of government bond. EE savings bonds earn a fixed interest rate. I savings bonds earn a fixed rate of interest plus an inflation based variable rate. Both earn interest for up to thirty years and can be redeemed any time.
Once you buy a savings bond, you cannot sell it to someone else. The only way to cash out is to redeem the bond. Redeeming a savings bond is subject to some restrictions. You cannot redeem bonds for a period after you purchase. Additionally, if you redeem it before enough time has passed, you’ll lose some of the interest that has accrued.
Unlike savings bonds, which earn interest that you do not see until it is redeemed, Treasury bonds and bond from other issuers give you regular payments. You can also sell these bonds to other investors if you need to cash in early. If you buy a $1,000 bond that pays 5% interest, you’ll get a check for $50 from the bond issuer each year. Once the bond reaches maturity, you’ll get the principal or face value of the bonds back. So, your $1,000 bond will pay you $1,050 the year it matures.
You can also purchase individual bonds from other issuers, including foreign governments, cities, or companies. Like people, bond issuers can go bankrupt. If that happens, any bonds that the issuer has sold will become worthless. Thankfully, like people, bond issuers have credit ratings. The worse the credit rating, the higher the interest rate the bond must offer to convince people to buy. Knowing how safe an investment a bond is important when deciding which bond to purchase.
Buy bonds in bulk
If choosing individual bonds is too difficult or time-consuming, you can invest in a bond mutual fund. Like stock mutual funds, bond funds purchase thousands of bonds, spreading out the risk. Unlike individual bonds, your share in a bond mutual fund will never reach maturity. Instead, your returns from a bond mutual fund will come from dividends. Each quarter the fund will pay you some of the money that it’s received from payments on the bonds. That make bond funds good for income seekers.
The price of shares in a bond fund and individual bonds that can be sold on the market can change. If interest rates get higher, existing bonds become worth less. That’s because people can buy new bonds with the same risk profile, and earn more money. Similarly, if interest rates decrease, existing bonds become worth more since new bonds offer less return. This comes into play if you ever have to sell a bond before maturity, or sell shares in your bond funds.
Using Both to Achieve Savings Goals
Bonds and savings accounts are both relatively safe investments, but they fit very different in your savings strategy.
Savings accounts can never lose money. That means you should use your savings account to store money that you absolutely cannot afford to lose. Savings accounts are also very liquid. You can ask for your money back at any time and the bank will give it to you. That makes savings accounts perfect for storing an emergency fund. While savings accounts offer less return than bonds, having quick access to cash and help you avoid debt. Avoiding credit card debt is one of the most important parts of maintaining your financial health.
Bonds, especially bonds from governments and major companies, also tend to be a safe investment. They can also offer much higher return than savings accounts. In exchange for the higher return, you give up flexibility because you cannot redeem bonds at any time. Their biggest advantage is that their regular interest payments are much larger than savings accounts. Additionally, the interest rate on a bond is guaranteed once you buy it. If you are nearing retirement, or want to turn a lump sum of cash into an income stream, bonds are the way to go. With some bonds lasting as long as thirty years, you can secure your income for some time to come.
Savings accounts and bonds both serve as safe ways to keep your money, but their different features give them different places in your savings strategy. Consider using both accounts to help you make the most of your money.