Are tax-free bonds better than CDs?
Key Takeaways. In general, tax-exempt municipal bonds (munis) are more attractive to those in higher tax brackets. To compare municipal bonds to taxable bonds, you need to determine the tax-equivalent yield of the muni. Though certificates of deposit (CDs) carry less risk, municipal bonds have tended to outperform them ...
Cons. Market prices could tank: If interest rates go up, the market prices of existing bonds will go down. That means you could have to sell your bond at a loss. Not inflation-friendly: Municipal bonds don't hold up against inflation as well as stocks do.
Choosing between a CD and Treasuries depends on how long of a term you want. For terms of one to six months, as well as 10 years, rates are close enough that Treasuries are the better pick. For terms of one to five years, CDs are currently paying more, and it's a large enough difference to give them the edge.
Credit Risk and Insurance. I bonds are backed by the full faith and credit of the U.S. government, which eliminates all credit risk and assures investors they will recoup their money at redemption. CDs are just as safe, but not due to an explicit government guarantee.
High-yield savings accounts, money market accounts and bonds can be good alternatives to CDs. Returns vary, but they're all considered low-risk investments. Regardless of where you keep your money, tending to your credit health is always a top priority.
Bonds are typically longer, higher-risk investments that deliver greater returns and a predictable income. Bonds are also more liquid than CDs because you can buy or sell them on the secondary market—although some bonds may be harder to sell than others.
Fund | 30-day SEC yield | Expense ratio |
---|---|---|
Vanguard California Long-Term Tax-Exempt Fund Admiral Shares (VCLAX) | 3.4% | 0.09% |
iShares National Muni Bond ETF (MUB) | 3.2% | 0.05% |
Fidelity Municipal Bond Index Fund (FMBIX) | 3.2% | 0.07% |
Invesco National AMT-Free Municipal Bond ETF (PZA) | 3.5% | 0.28% |
GO bonds are usually considered safer than revenue bonds, as a municipality can raise taxes to cover outstanding debt obligations. In contrast, revenue bonds are subject to the earnings made by that particular project.
Municipal Bonds
Most bonds issued by government agencies are tax-exempt. This means interest on these bonds are excluded from gross income for federal tax purposes. In addition, interest on the bonds is exempt from State of California personal income taxes.
Cons of CDs Explained
Lower returns than other investments: CDs offer limited returns if you want to build wealth. You can often get better returns for your money by putting it into the market and buying stocks, mutual funds, or other investments instead—as long as the market is on an upswing.
Are CDs good to buy during a recession?
They are guaranteed by the bank to return the principal and interest earned at maturity. CDs can provide modest income during turbulent economic times like recessions when other types of investments often lose value. CDs are protected up to $250,000 by the Federal Deposit Insurance Corporation (FDIC).
Bottom line. When deciding between a long-term CD or putting money in the stock market, always take into account your goals and how long you'll need to achieve them. For long-term plans like retirement, the market offers better returns than locking up your cash in a CD.
According to the Federal Deposit Insurance Corporation (FDIC), the independent government agency that protects funds deposited in banks, no one has ever lost a single cent invested in CDs it backs. Even if a financial institution is forced to close its doors, your money is safe up to the insured limit.
Cons: Rates are variable, there's a lockup period and early withdrawal penalty, and there's a limit to how much you can invest. Only taxable accounts are allowed to invest in I bonds (i.e., no IRAs or 401(k) plans).
U.S. Treasuries are considered among the safest available investments because of the very low risk of default. Unfortunately, this also means they have among the lowest yields, even if interest income from Treasuries is generally exempt from local and state income taxes.
There are no national or community banks offering 7% interest on a savings account right now. Landmark Credit Union, which serves residents in select counties in Wisconsin and Illinois, pays 7.50% APY on its Landmark Credit Union Premium Checking Account — however, there are some major caveats to consider.
Currently, Treasuries maturing in less than a year yield more than CDs. However, at maturities of one year and beyond, CDs yield a little more before taxes. Therefore, all things considered, it likely makes more sense to choose Treasuries over CDs for shorter-term investments, but it depends on your situation.
5 tips for keeping your money in CDs insured
Stay at or under $250,000. Ensure your CD deposit and the expected interest will total less than the $250,000 limit. Open CDs at different banks or credit unions. This approach might take more work, but you can utilize CDs at different rates and terms.
Fixed income valuations, and a different inflation profile to the past few years, should make 2024 a good year for bonds. However, as with this year, it will not be all plain sailing.
- Historically, bonds have provided lower long-term returns than stocks.
- Bond prices fall when interest rates go up. Long-term bonds, especially, suffer from price fluctuations as interest rates rise and fall.
How much does a $10,000 CD make in a year?
If you deposit $10,000 into a one-year CD that pays the national average of 1.81% APY, the value at maturity would be $10,181. However, if you deposit $10,000 into a one-year CD that earns 5.35% APY (the top APY from our list), it would be worth $10,535 at maturity.
Municipal bonds, like all bonds, pose interest rate risk. The longer the term of the bond, the greater the risk. If interest rates rise during the term of your bond, you're losing out on a better rate. This will also cause the bond you are holding to decline in value.
For investors in higher tax brackets, we believe that municipal bonds currently offer a compelling balance of risk and reward. Yields for these often tax-exempt fixed income securities are at attractive levels even as interest rates in general appear to be headed lower.
Tax-free bonds are issued both in demat format and physical mode. Credit risk or the risk of non-payment is very low in tax-free bonds as these bonds are mostly issued by the government enterprises. Interest rates on tax-free bonds ranges between 7.3% to 7.5% per year.
Interest rate risk.
U.S. interest rates have been low for some time. If they move higher, investors who hold a low fixed-rate municipal bond and try to sell it before it matures could lose money because of the lower market value of the bond.