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Can bonds replace CDs?

By Sheyna Steiner · Bankrate.com
Friday, July 30, 2010
Posted: 10 am ET

This year, CD rates have hit unprecedented lows. What are beleaguered CD investors to do?

One avenue, suggests Bill Larkin, fixed-income portfolio manager at Cabot Money Management in Salem, Mass., is to try bonds.

Rather than bonds funds, as I've written about in a previous post, Larkin suggests some of his clients buy bonds rather than CDs to combat today's rates -- if, that is, they're interested in short-term investments.

To get a higher yield, there are three methods: there is liquidity, giving up your ability to liquidate your position; there is duration, saying I'm just going to go a little bit longer; and then there is credit risk, going from CDs to bank debt or corporate bonds, or high-yield, he says.

Though you give up the FDIC guarantee if you buy a corporate bond in place of a CD, investors can mitigate the risk of default by focusing on mega-brand companies such as Coca-Cola, McDonald's or GE, to name a few.

"Some of these companies probably have the most cash that they've had in a long time which should make bond holders more comfortable. And they have market positions that are dominant. We're talking about low-risk investments," says Larkin.

Buying a bond requires a little more due diligence than buying a CD.

For one, you need a brokerage account, but that's a low barrier.

Secondly, and possibly more difficult, "you should be able to read a balance sheet too, which is hard for some people. You used to be able to say, 'well, it's AA but you can't say that anymore,'" says Larkin.

So, you do definitely need to know what you're buying.

Finally, when interest rates do finally rise, bond prices will likely be negatively affected but, "if you're doing short term stuff that's not a problem," Larkin says.

Bonds are of course, a more risky investment than CDs but are better yields worth it?

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