Bond funds are especially prone to at least two risks that can hurt performance and reliability. 

The first is rising interest rates, which will usually cause a decline in the values of bonds held within the mutual fund—and a drop in the fund’s net asset value. The second is a deterioration in the ability of the bond issuers to make expected interest payments, and return the principal to the bondholders upon maturity.

These issues are damaging enough to investors who hold individual bonds. But those who own bond mutual funds while either (or both) events are occurring can experience significant losses, especially if net redemptions from the bond fund force the managers to liquidate positions at reduced prices.

However, with FDIC-insured certificates of deposit the risk to principal and interest is about as close to zero as fixed income investors can get, regardless of the behavior of other investors. And yes, in a rising interest rate environment, owners of broker-sold CDs may see a decline in value of the investments on their monthly statements. But that decline will evaporate as the CD maturity date draws closer and the estimated worth of the CD nears its originally-issued face value.

According to Morningstar, mutual funds are only required to report their portfolio holdings twice per year, and the information may not make it into the public until up to two months after each reporting date. 

Most funds report holdings more often than twice per year, but often the information represents just a “snapshot” of what the fund held on a given date in the past. Not only is it difficult for you (and your clients) to know what’s in most bond funds, but there may be a disconnect between the fund’s name and the perceived investments.

For instance, “government” bond funds might own mortgage-backed securities or zero-coupon Treasuries. They may also employ such strategies as leverage and derivatives to enhance returns. There is usually nothing inherently wrong with these investments, but they may add a layer of risk to the bond fund that will only be discovered and discussed when things go wrong.

For better or worse, most bond mutual funds are perpetual, as there is no defined date or promised future value. But CD owners can take comfort in the knowledge that if they hold their securities to maturity, they will get their interest and principal as expected.

Many broker-sold CDs also offer an “estate put” or “survivor’s option,” so if the client dies while owning the CD, the surviving inheritors have the option of cashing in the CD for the face value plus any accrued interest, regardless of the CD’s current market value or maturity date. Although clients who need the proceeds from a broker-sold CD before it matures usually must sell it in the secondary market for a price that may be more or less than the original face value, CDs offered directly from banks and credit unions usually have a fixed penalty for early withdrawal, often six to twelve months’ worth of interest. That means that if interest rates rise after clients have invested in CDs obtained from banks and credit unions, the clients can withdraw the money before maturity in pursuit of higher yields elsewhere, incurring only a small loss on the withdrawal. 

When shopping for a direct-offered CD, clients should usually choose one that offers the longest maturity and highest yield.

A few minutes of shopping around online or in your firm’s inventory can find CDs that can meet or beat the prospective yields offered by bond mutual fund portfolios of comparable quality. 

For instance, take the Vanguard Intermediate-Term Treasury ETF (VGIT). According to Vanguard’s website, as of 1/11/2019 the 30 day SEC yield of the fund was 2.58 percent. As of 11/30/2018, the average effective maturity of the fund’s holdings was 5.6 years and the average duration was 5.2 years. At the same time, many broker-sold CDs in the five-year maturity range were paying around 3.20 percent, and several banks and credit unions nationwide were offering five-year CDs direct to customers with similar or higher yields.

True, unlike CD interest, the interest on a bond mutual fund comprised entirely of Treasuries could be exempt from state taxation. But that distinction doesn’t matter to clients who live in states with no income taxation, or who are investing in tax-sheltered retirement accounts. And it likely doesn’t make up for the potential risk and volatility inherent in investing in a bond mutual fund, compared to the certainty of a CD.

According to the latest information available from the Investment Company Institute, the average asset-weighted bond mutual fund expense ratio is 0.48 percent, and it’s 0.18 percent for exchange-traded bond funds. Those figures appear to be reasonable, but in the current low interest rate environment those expenses eat up a substantial portion of the yield generated by the fund’s portfolio, reducing the overall return.

Certificates of deposit have no ongoing expense ratio; therefore, all of the interest paid by the CDs goes directly to the owner.

Unlike many broker-sold bond funds, CDs have no similar sales or redemption charge. However, brokered CDs may have a small transaction fee when bought, or when sold before maturity.

In addition, if a client is selling a CD before maturity or buying one in the secondary market, there may be a spread between the “bid” and “ask” prices offered by the CD market maker. CDs offered directly by banks and credit unions have no sales charges or expenses, but the client will likely incur the aforementioned penalty if redeemed early.