Are online savings accounts a better choice than bonds?

[stilllearning]

At about 5% interest and hardly any risk, online accounts seem like a better option than bonds, as bonds are riskier and don't seem to return a much higher rate. Am I missing anything?

[terry1156]

At this time the online banks make more sense.

[disneysteve]

I think it partly depends on your needs, your timeline and the type of account you are talking about.

Online bank accounts are taxable. Bonds could be held in a tax-free account.
Online bank interest rates are variable and can change at any time. Most bond interest rates are fixed. If you hold the bond to maturity, you know exactly how much you will end up with.
Online bank accounts are liquid. You can withdraw or add to your funds at any time. Bonds are not as liquid. Selling a bond can trigger fees and, depending on prevailing interest rates, your bond could lose value compared to purchase price.

[humandraydel]

If interest rates go down tomorrow, you will wish you had your money in bonds. If interest rates rise tomorrow, you will wish you didn't. This is why people often suggest CD or bond "ladders"

[stilllearning]

I forgot about the tax-free option for bonds. Can you elaborate more on what a CD or bond "ladder" is?

[disneysteve]

I forgot about the tax-free option for bonds. Can you elaborate more on what a CD or bond "ladder" is?

A "ladder" refers to buying a series of CDs or bonds with different maturity dates. That way, if interest rates change for the better, you periodically have something maturing that you can then use to take advantage of the higher rates. If rates fall, some of your money will have to be reinvested at the lower rate but the rest will still be locked in at the higher rates.

There are lots of ways to ladder depending on your needs, timeline and amount of money involved. For example, you could buy a 1-yr, 2-yr and 3-yr CD. When each comes due, renew it for 3 years. Then, every year a CD would come due.

[stilllearning]

Interesting concept. Is the interest rate of a CD guaranteed though? I was under the impression that a bank could lower the interest rate of your CD if the going rate was declining.

[disneysteve]

No. A CD rate is fixed at the time of purchase. There are some new-fangled CDs that have weird conditions and are somehow tied to stock market performance and stuff like that, but traditional basic CDs have a fixed rate and a fixed term.

[stilllearning]

Thanks--this have been very helpful. I have a few more last questions if that's alright.

What happens if you do not withdraw your money or renew a CD before it is over? Any penalty? Do you just revert back to a lower interest rate?

So bonds have a set maturation date as well, what happens after this date comes up? Can you still make money out of them?

Are there any differences if you buy the bonds in the form of an index fund?

Are bonds suppose to have a set interest rate you get out of them created by the government? ...because they go up and down like stocks do, right?

Still trying to understand this stuff, thanks.

[sweeps]

There are lots of different CDs as there are lots of different bonds. Most CDs have a penalty if you withdraw early, for example 6 months of interest.

Often when someone talks about investing in bonds, they're talking bond funds. An investment in a bond fund never "matures" and you can lose money.

You can usually sell an individual bond before it matures -- however what you can get by selling it varies based on interest rates and other factors. You can always hold an individual bond until it matures.

[disneysteve]

What happens if you do not withdraw your money or renew a CD before it is over?

If you don't take out the money, the CD automatically renews at whatever the rate is at that time. No penalty for that.

So bonds have a set maturation date as well, what happens after this date comes up? Can you still make money out of them?

Are there any differences if you buy the bonds in the form of an index fund?

Are bonds suppose to have a set interest rate you get out of them created by the government? ...because they go up and down like stocks do, right?

If you purchase an individual bond, it might be issued by local, state or federal government agencies or by private companies. It will have a particular term and interest rate. If you hold it until it matures, you will get face value plus interest. If you sell it before it matures, you might get more or less than face value depending on what has happened to interest rates since you bought it. Once the bond matures, you get your money back.

With a bond fund, you are buying into a pool of bonds with varying rates and terms. As sweeps said, a bond fund never matures, though individual bonds held by the fund might. The money just gets reinvested in other bonds. The net asset value of the fund could rise or fall depending on market conditions and the underlying value of the bonds held in the fund.

As for "going up and down like stocks", a bond's value only comes into play if you sell it before it matures. A $1,000 bond will mature for $1,000 but if you choose to sell it early you might get more or less than $1,000. That isn't quite like stocks that don't have a set "face value" that is guaranteed at a certain point.

[Scanner]

Interesting discussion.

First of all, remember that most online savings account rates that you see are teasers - the 5% is only for like 3 months and then it reverts to 3.14% or something of that magnitude.

You could theorectially hold a savings account in a "tax-free" account, that is, set up a Roth or Traditional IRA with an online savings account, just like I could set up my own silver trust and have my Roth be comprised of silver bars.

The gov't gives you a lot of latitude on where to invest your money.

Both are considered "debt sector" investments - that is, you are loaning money to somebody with a promise to you to pay it back + interest.

A stock is an equity sector investment that gives you ownership of a company and it's profits (or losses).

Anyway, you have to decide if a savings account is paying 3.14% and a bond pays 5.5% if the FDIC insurance and illiquidity is worth the extra payout.

Over time, it is.

In the short term, it probably isn't.

I am a big fan of muni bonds and often suggest them here often because they escape taxation. You can also obtain insured muni bonds (not FDIC, I forget the agency) so you are not risking as much.

So. . .let's say we both have $20,000.

You put yours in a savings acct. at 3.14% interest, which will probably net out around 2.5% interest with taxes.

I buy 4 $5000 insured muni bonds at 4% interest that without taxation nets let's say 5% interest.

With the insurance, both have equal risk.

Which would you choose?

I'll admit though, they have been a hard sell here though and for some reason many around this forum like online banks to park their money. It's probably just simplicity, rather than return and risk.

Me, I enjoy the thought of my money earing interest tax-free.

[sweeps]

First of all, remember that most online savings account rates that you see are teasers - the 5% is only for like 3 months and then it reverts to 3.14% or something of that magnitude.

Maybe a few do this, but "most"? No way.

[disneysteve]

First of all, remember that most online savings account rates that you see are teasers - the 5% is only for like 3 months and then it reverts to 3.14% or something of that magnitude.

I don't think this is generally true. Look at the thread at the top of this board. There are currently 16 banks paying 5% or more. None of those are teaser rates.

You put yours in a savings acct. at 3.14% interest, which will probably net out around 2.5% interest with taxes.

I buy 4 $5000 insured muni bonds at 4% interest that without taxation nets let's say 5% interest.

With the insurance, both have equal risk.

Which would you choose?

I'll admit though, they have been a hard sell here though and for some reason many around this forum like online banks to park their money. It's probably just simplicity, rather than return and risk.

I think you are comparing apples and oranges. First of all, why would anybody pick a savings acct at 3.14%? The top accounts now are at 5.36% or even more with a higher balance.

Second, most people here are using their savings account for emergency money that they want to be able to access anytime without penalty and are willing to sacrifice a few tenths of a percent interest to have that flexibility. If your car breaks down and your "emergency" money is tied up in muni bonds, it takes a little time to get to your funds. Plus, you'd need to cash in the whole $5,000. You can't redeem half of a bond if you only need $2,500. With a high yield money market, you just do an electronic transfer to your checking account for the exact amount you need. Some accounts even have debit cards or check-writing privileges which makes accessing the money simple.

Third, the benefit of munis is greater if you are in the highest tax brackets. For someone in a lower bracket, they aren't such a good deal. To use your example, if you are in the 25% bracket, a 5.36% savings acct would be 4.02% after taxes and the 4% muni would be 5% tax equivalent, so the muni wins. BUT, if you are in the 15% bracket, the savings acct is 4.556% after taxes and the muni is 4.60% tax equivalent. The muni is still ahead, but only by 0.044% which isn't enough to make it worth losing liquidity.

[Scanner]

For emergency money, yes, something liquid.

But I thought we were talking investments.

Anyway, I must confess - I only checked 2 banks and they offered teaser rates. I thought that was the norm.

If 5.36% is the norm for FDIC insurance, yes, it's hard to beat that with a stick.