Between 1928 and 2011, the safest form of bonds -- Treasury bills -- returned 3.61 percent a year. As of 2013, the average savings account pays just 0.21 percent a year. However, U.S. banks hold more than $1.7 trillion in deposits, according to the Federal Reserve. Banks remain a popular savings option because of the flexibility and security they offer.
Bank accounts typically carry relatively low interest rates. As of early 2013, some banks offer savings interest rates as low as 0.01 percent, while online banks offer rates of about 1 percent. However, a 10-year Treasury bond has a yield of about 1.8 percent. Inflation-indexed government bonds like I Bonds and Treasury inflation-protected securities have yields that are at least the rate of inflation.
Bank deposits are insured by the Federal Deposit Insurance Corporation up to $250,000 per depositor per bank, as of 2013. Even if your bank goes under, you will get your money back from the FDIC. When you buy bonds, your ability to get your money back is based on the strength of the organization that issued the bonds. If you buy bonds issued by the Treasury, they are backed by the full faith and credit of the U.S. government -- just like the FDIC insurance that protects bank accounts. However, if you need to sell your Treasury bond before its maturity, you will be subject to whatever price the market will bear. Unlike a bank account where a dollar is always a dollar, bond prices can change significantly. If the bond goes up in value, which is more likely if the issuing company becomes stronger or interest rates in the economy drop, you may be able to sell the bond to another investor for more than its value. However, if the issuer becomes weaker or interest rates move up, your bond will be worth less money. While these factors don't come into play if you buy the bond at face value and hold it until maturity, they can become an issue if you need to sell the bond before it matures.
When you have a lump sum of money that you can invest for a long period, bank accounts can become more attractive. Certificates of deposit pay higher interest rates in exchange for your agreement to leave your money in place for a set time. However, long-term bonds also pay higher interest rates. Not only do you get a higher rate because of your willingness to commit your money but you're also taking more risk. Inflation is more likely to become a factor over the long term, and you're also more exposed to the company and the strength of its credit rating, which can change over time. Finally, inflation-indexed bonds may not offer particularly high rates of return over inflation.
The interest you earn on your bank deposits is taxable, as is the amount you get on most bonds. However, municipal bonds are tax-free. These bonds are issued by cities, counties or states to help pay for projects. As a way to make it cheaper for local governments to borrow money, Uncle Sam has designated their interest to be tax-free, which lets them borrow at a lower rate. While municipal bonds won't pay you as much interest as a comparably rated corporate bond, the tax savings can make them a sound investment.
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