The decision to invest in bond funds or online high-yield savings account depends upon your investment goals, the return you expect on your investment, and the current economic climate. Both bond funds and high-yield savings accounts generate income based on interest rates. In a strong economy, for example, short-term interest rates are higher, while in a weaker economy, short-term interest rates are lower. Although bond funds are more volatile, they tend to return higher yields than online high-yield savings accounts.
Types of Investments
Bonds represent a portion of a government or corporation's debt. When an investor buys bond funds, he buys shares of a fund that is invested in various types of bonds. Online high-yield savings accounts are bank accounts into which an investor deposits a fixed sum of money for a fixed amount of time. Bond funds invest in various types of bonds for various periods of times. The bank issuing your savings account uses your money to make investments that return a higher yield than the interest rate it pays you.
Earning a Return
Bond funds and online high-yield savings accounts respond to market factors differently. Both types of investments are professionally managed, so the returns will vary based on the investments the bank or fund manager makes. Bond funds return interest payments to investors monthly, whereas the schedule on which banks compute interest payments for savings accounts varies by institution. Bond funds add diversity to an investment portfolio because they are comprised of several types of bonds. Online high-yield savings accounts add security to an investment portfolio.
Online high-yield savings accounts and bond funds earn revenue based on interest rates. Because each type of investment reacts differently to rate changes, this can affect the return an investor receives. Investors in bond funds buy shares of the fund, not the bonds themselves, so the value of a bond fund tends to drop as interest rates rise. Online high-yield savings accounts create revenue based on interest rates, so their ability to earn revenue increases as interest rates rise.
Volatility measures the degree and frequency a security's price deviates from its statistical mean over a period of time. Standard deviation is one way to approximate the volatility of a bond fund or an online high-yield savings account. In general, bond funds are less volatile than funds that invest in stocks. The interest rate a savings account earns is based on the federal funds rate, and is designed to hedge against inflation, which means savings accounts have low volatility. Online high-yield savings accounts, however, tend to be more volatile than traditional savings accounts.
- Securities and Exchange Commission: "Bond Funds and Income Funds"; March 29, 2010
- Fidelity Brokerage Services: Fixed Income -- Understanding Bond Funds
- Kiplinger's Personal Finance: "Eleven Bond Funds That Won't Get Soaked by Rising Interest Rates"; Jeffrey R. Kosnett, Feb. 16, 2011
- Market Watch: "Tired of Volatility? Try Bond Funds"; Michael Molinski, Sept. 14, 2000
- Bank Rate: Federal Funds Rate
- Comstock/Comstock/Getty Images