As a long-term investor, it’s natural to want to protect your investments. You may have heard that bonds and fixed term deposits are solid options when preserving capital is your priority. But which option is safer?

While we don't deal in absolutes – like "safer" – we do like to provide comparisons of different asset classes. This way, you can make the choice which aligns most closely with your goals. That's why, in this article, we’ll explore the differences between bonds and fixed term deposits.

Understanding how bonds and fixed term deposits work can give you the confidence to choose investments aligned with your long-term goals. Let’s compare both options side by side.

What are bonds?

A bond is a loan an investor makes to governments or companies. In return, they pay you interest regularly and repay the loan at maturity. As fixed-income assets, bonds are generally considered less risky than shares (with all things being equal).

Though a bond can offer a steady income stream, its value can change if interest rates rise or fall. A government bond is generally seen as lower risk than a corporate bond, which may offer a higher rate of return but with potentially more risk.

Bondholders earn interest payments, also known as coupons. These are typically paid regularly to the investor until the bond matures – when the principal amount is returned. A bond can also be sold before maturity, potentially leading to a capital gain or loss depending on market conditions.

While bonds are often seen as less risky, they aren’t risk-free. Key risks of investing in a bond include:

• Credit risk : The issuer may default on payments, meaning you could lose your interest or principal.
• Interest rate risk : When the Reserve Bank of Australia (RBA) raises interest rates, bond prices typically fall. This can potentially result in losses if you sell before the maturity date.
• Inflation risk : Rising inflation can reduce the purchasing power of your returns, eroding the real value of the bond over time.

What are fixed term deposits?

A fixed term deposit is an investment where you deposit money with a bank for a set period. In return, you receive a fixed interest rate over that time. Interest-bearing term deposits are quite straightforward and can offer stability, as your original deposit is guaranteed.

With a fixed interest rate, you know exactly how much you'll earn by the end of the term. The interest is usually paid to the investor at the end of the term, though some pay regular interest. The return is typically lower than other investments, but the predictability can make them appealing for a conservative investor.

While a fixed term deposit can offer safety, it can also come with some risks:

• Inflation risk : Rising costs can reduce the real value of your returns, decreasing purchasing power over time.
• Liquidity risk : Access to your funds is limited, and early withdrawal often incurs penalties.
• Lower returns : Fixed term deposits may offer lower returns than other investment options, despite the security of principal.

How do bonds and fixed term deposits compare?

Let’s look at how bonds and fixed term deposits stack up against a few key factors:

Capital safety

A fixed term deposit offers guaranteed capital protection from the bank, while a bond depends on the issuer's creditworthiness. Government bonds are typically safer than corporate bonds but are still subject to some risk. Fixed term deposits, covered by Australia’s Financial Claims Scheme , guarantee up to a certain limit if the bank fails.

Income certainty

Fixed term deposits offer guaranteed interest payments to the investor for the entire term. Bonds provide income through coupon payments, but the amounts can vary, especially with floating rate bonds . The amount can also be affected if you sell before the maturity date. This can make a fixed term deposit more predictable for an income-focused investor.

Interest rate sensitivity

Bonds are sensitive to changes in the cash rate . If rates rise in response to RBA monetary policy decisions, bond prices usually fall. This potentially leads to losses if sold early. However, fixed rate bonds are another alternative to manage interest rate sensitivity. A fixed term deposit locks in the interest rate for the entire term, so your returns won’t change even if interest rates rise after you invest.

Liquidity and flexibility

A bond can be sold before maturity, providing more flexibility. But this might result in a loss if market conditions change. Fixed term deposits lock your funds for the agreed period, and withdrawing early usually incurs a penalty, making them less flexible.

Inflation impact

Both bonds and fixed term deposits are vulnerable to inflation. But bonds, especially those with longer maturities, may be more affected. Inflation erodes purchasing power, meaning the real return from both can be reduced if inflation rises sharply during the investment period.

Prefer a side-by-side comparison of the two investment types? Here’s a table capturing a summary:

Criteria	Bond	Fixed term deposit
Capital safety	Dependent on issuer's creditworthiness; some risk remains.	Guaranteed by the bank up to a certain limit.
Income certainty	Coupon payments, may vary; affected by market changes.	Fixed interest rate, predictable income throughout the term.
Interest rate sensitivity	Sensitive to rising interest rates, potential price decline.	Not affected by rate changes during the term (for good or for ill).
Liquidity	Can be sold before maturity but may incur losses.	Funds are locked in; early withdrawal may incur penalties.
Inflation impact	More vulnerable with longer terms; real returns may fall.	Inflation reduces real returns over time.

An investor can benefit from both bonds and fixed term deposits, but each comes with its risks. A bond may provide a higher rate of return with more flexibility, but can carry greater risk. This is especially the case in a fluctuating interest rate environment. A fixed term deposit tends to offer security and predictability, though inflation can potentially reduce their real value over time.

Bond vs fixed term deposit: factors to consider

When building your long-term investing strategy, choosing an option that fits your unique needs is important. Whether you prioritise stability, flexibility, or potential returns, understanding these five key factors can help you make a more informed choice.

1. Time horizon

Your investment timeframe plays a crucial role in choosing between bonds and fixed term deposits. Bonds can often suit long-term investors , especially if you can hold them until maturity. Fixed term deposits can be better for short-term goals since your funds are locked in for a specific period, usually ranging from a few months to a few years.

2. Liquidity needs

If you require flexibility, bonds may be more suitable since they can be sold before maturity. However, selling bonds early can lead to potential losses depending on market conditions. Fixed term deposits offer less flexibility, because as we mentioned earlier, accessing funds before maturity typically incurs penalties.

3. Risk tolerance

Consider your comfort with risk. Bonds generally carry more risk than fixed term deposits, especially corporate bonds, which may involve credit risk. Fixed term deposits are potentially lower risk, as the original deposit is guaranteed, but they often offer lower returns.

4. Income expectations

If you're seeking predictable income, fixed term deposits offer fixed interest rates that remain constant for the duration of the term. Bonds provide regular interest payments but may fluctuate based on market conditions, especially if sold before maturity.

5. Inflation impact

Both bonds and fixed term deposits are vulnerable to inflation. Inflation reduces the purchasing power of your returns. Bonds, particularly long-term ones, can be more susceptible to this risk. Fixed term deposits lock in returns, so their purchasing power erodes if inflation rises during the deposit term.

Ultimately, it comes down to what works best for you. Both bonds and fixed term deposits can have a place in your strategy, depending on what you're aiming for. Just take the time to think through the risks and rewards of each.

Bonds and fixed term deposits in market conditions

Looking at how bonds and fixed term deposits have performed in different situations can help you understand their strengths and weaknesses.

Bonds in rising interest rate environments

In Australia, when the RBA raises interest rates, bond prices often drop. For example, if you bought a bond when rates were lower, its value might decrease if sold before it matures. However, holding the bond until maturity means you'll still receive your regular interest payments. Keep in mind that this scenario doesn’t predict how bonds will behave in the future.

Fixed term deposits during low interest periods

In times of low interest rates, fixed term deposits usually offer modest returns. For instance, if you lock in a fixed term deposit when rates are low, your earnings may be limited compared to other investments. Still, your capital is protected, and the interest rate is guaranteed. Just be aware that past performance doesn’t guarantee future outcomes, especially if interest rates change.

Inflation's impact on both

As we detailed above, high inflation can reduce the real returns of both bonds and fixed term deposits. For example, earning 3% interest while inflation is at 5% means your returns lose purchasing power. Even though you’ll still receive the promised interest, inflation affects the true value of what you earn. Again, how inflation affects returns in the future can vary, so it’s important to consider current conditions.

Hypothetical scenarios: choosing bond vs fixed term deposit

When comparing bonds and fixed term deposits, it also helps to look at some fictional examples:

Jemima: prioritising capital preservation with fixed term deposits

Jemima is a 60-year-old retiree looking to preserve her capital while earning a predictable income. She prefers minimal risk and values the security of knowing her money is protected. Given her short-term goals and low risk tolerance , Jemima chooses a fixed term deposit that guarantees her principal and provides a fixed interest rate. While she understands the returns are modest, the certainty of her investment helps her feel secure about her future. However, past stability in fixed term deposits doesn’t guarantee future performance, especially with inflation.

Rajesh: seeking long-term growth with bonds

Rajesh is 35 and planning to grow his savings over the next 15 to 20 years. He’s comfortable taking on some risk in exchange for potentially higher returns. Rajesh invests in government bonds, knowing they offer regular interest payments and the opportunity for capital gains if he holds them until maturity. While he’s aware bond prices may fluctuate, he is confident he can ride out market changes due to his long investment horizon. That said, it’s important to note that past bond performance isn’t a reliable predictor of future results, especially in changing market conditions.

Like Jemima and Rajesh, the choice between bonds and fixed term deposits depends on your financial goals, risk profile, and market outlook. You might find that adding both to your portfolio offers a balanced approach, or you might decide neither aligns with your current strategy. Choose what’s right for you based on the information available and your long-term goals.

Find your right fit

When deciding which is "safer" – bonds or fixed term deposits – the answer depends on your personal situation and preferences. Bonds can offer higher returns and flexibility, but they carry more risk. Fixed term deposits can give you stability and predictable returns, though inflation might eat into their value.

There’s no one-size-fits-all answer here. Whether you go with bonds, fixed term deposits, both, or neither, the important thing is to pick what aligns with your objectives. The right choice is the one you’re comfortable with and will get you closer to your desired financial future.