“Should I invest in CDs or a Roth IRA?”

31 Comments

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[Update]: See below for some great (and controversial) comments debating my stance that bonds are not for young people.

Sherene writes:

I am a recent college graduate and I want to put the little money I have saved (approx $3,000) into something that will give me good returns over the years. Would you suggest I get CDs or a Roth IRA?

The two are very different.

A Roth IRA is an investment account, but once you get it, you have to put money in it and invest. You can read all about it on my article The World’s Easiest Guide to Retirement Accounts.

A CD is a type of investment, which you can buy inside (or outside) of any investment account. And if you’re wondering what I think about CDs/bonds…

Bonds aren't for young people

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31 Comments

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  1. NO bonds at all? what is your age cut off? I’m 25 and have 10% of my asset allocation in bonds. Too much?

  2. That’s a hilarious picture! However, what about getting a compounded rate of return? Investing in index funds will provide a better yearly rate of return number, but you are dealing with major market swings and potentially taking major losses that take years to recover (2001 for instance). Bonds stablize a portfolio and protect you on the downside. A cliche’ example would be that a portfolio that goes up 20% & down 10% repeatedly would be outperformed by a portfolio that goes up 10% every year. The gain percentage is the same, but the dollar amount you are compounding on is larger with the latter. I’m a 24 year old investment consultant, and I think bonds are absolutely for young people. The idea is to never lose money. Stocks/Mutual Funds/etc have their place in a portfolio to add what I call “the juice” but for me, I wouldn’t recommend any more than 60%. Also, there are plenty of alternative investments paying 10% or more per year but I won’t get into all that…

  3. I agree with the majority of what you say on this blog but this is the first time where I think you’ve said is completely wrong. There is nothing wrong with CD’s for young people if used properly. I’m 26 and I have my 6 months of emergency funds laddered in CD’s so that one matures each month and gets reinvested. This allows them to accrue more interest than sitting in a regular savings account and gives me access to the money when I need it.

  4. Hey Henry and Evan, you’re both technically right — bonds can be used to reduce risk, and for short-term goals like buying a house or laddering emergency funds.

    But in practical terms, bonds are simply one more confusing thing that young people have to deal with when they make investment decisions. And it’s one more confusing thing that stops young people from getting started investing.

    I’ve said this before (in The Best Decision vs. The Financially Correct Decision) and I’ll say it again, iwillteachyoutoberich is about removing confusing choices and presenting a few simple options for getting started. If that means you keep your emergency fund in a high-interest fund, or use a lifecycle fund to invest (so they reduce risk for you), those are two simple ways to reduce complexity.

    I’d rather beginning investors do something 85% of the way than not do it at all.

  5. Personally, I use Muni bonds in my brokerage account while the funds are in holding to go into my Roth. Once in my Roth, they’re sold and ETFs purchased. Simple reason why I do this: lower my tax liabilities at the end of year, and increase my tax-effective return.

  6. Hmmm … when I look for investing advice, I usually look to the best in the business. That’s why I went to Warren Buffett’s Annual General Meeting in Omaha.

    He suggested that IF you don’t really know what you’re doing, that you should dollar-cost average (that means put a little bit over time) into little pieces of all of “American Business” … he later clarified that to mean a low-cost Index Fund (in fact, he named Vanguard).

    Why? Well inflation will keep your CD’s worthless … by buying and holding Index Funds (LOW-COST ones) for a VERY LONG time, the market will go up (there hasn’t been a SINGLE 30-year period where the market hasn’t avergaed an 8% return) and you will stand a better chance to beat inflation …

    … of course, neither strategy will make you rich (or even financially free at a young age) the latter will keep you out of the poor house, and give you a chance of retiring at 55 or 65.

  7. I like how brief yet complete the answer is. It is interesting to see the financial world has managed to confuse people for things that are very different.

    On a critical note, I find the image to be disturbing. I understand your point about motivating people, but I would hope there is a better way. Are half-truths the only path to action (or 85% as you say), and does the whole truth really sound overwhelming and lead to complete inaction?

    I live on the premise that people can handle the truth. Bonds are an important investment category. It’s not any harder to invest in them than stocks–there are even bond mutual funds or index funds, often included in company 401(k) investment options.

  8. Wow, the comment about CD’s and bonds is bound to create a firestorm of response.

    Usually I agree with your advice, but this time I think it is too sweeping. It is too one size fits all and personally I disagree. There are times to put your money in a CD even if your are young. For example, you can get a better return for short term savings (car, college, etc). It can also be a place to park your money when the market is too volatile for your risk tolerance. While a money market is a good option, sometimes you want to have the funds locked up for a period of time and unavailable.

  9. When I first moved out on my own, I knew about checking accounts and savings accounts. My Nana started talking about CD’s and so I asked her what they were. After minimal advice, I called around and invested in a short term CD. That was the FIRST investing I ever did and it was easy. Eventually, I learned how to ladder CD’s.

    I understand your point on one level, but CD’s are so easy I don’t see any reason for a new investor to shy away from them. I certainly don’t advocate putting all your money into CD’s, but to have a couple for an emergency fund is really not that much more complicated than setting up a savings account or money market account, both of which tend to earn less interest.

    I would never have invested in stocks or other options had it not been for my initial investment in CD’s. I understand how youth helps to reduce risk since you can keep your money in investments longer. But, when just starting out, the last thing I wanted to see was all my investments tank. Having a small portion in the safe option was the best for me.

  10. Wow. Okay, I really need some more, clear, easy education on my finances. Ramit, when is your book coming out already!?

  11. I generally agree with Ramit on this issue. The point is to simplify the solution. If the question is being asked, the simplest solution will not be to invest and explain CD laddering. The priorities should be some type of emergency fund (high yield is optimal) and then throw some money toward the future in the simplest way. There are enough years to complicate the situation.

    I would say in this instance the individual should put the money into a savings account as emergency fund, bubble, whatever you want to call it. But it should remain liquid and accessible. If that’s taken care of, open up a Roth and check out some low cost index funds.

    It’s as simple as that. Over the years you can ramp up a “semi liquid” ladder of CDs or more complex investments in the Roth. But for now the entire point is to simplify the situation, and I do not think bonds enter the picture until there is a more fundamental base.

  12. I’m mostly in agreement that one should stay away from bonds….

    Interest rates are appalling right now. Why would you want to lock in that?

    That means Treasuries aren’t very pretty, especially if you consider current levels of inflation. I-bonds you say? They pay 0% right now.

    The story is pretty much the same with CDs. My mom loves CDs. Why in the world, I’ll never understand, but then, she’s also much older and has far more conservative risk tolerance, so I guess that’s OK for her.

    About the only thing I like for right now is select muni-bonds, which is a little surprising. But that just goes to show that you have to shop around.

    If asset protection is what you’re looking for, bonds are not the only option available to you. For example, precious metals are an interesting alternative. The only bad thing is that they’re running at an all-time high right now, even if the levels have recently fallen a bit….

    But honestly, if you’re young (20′s to 30′s), and you don’t think the sky is going to fall, I say go all-stock.

    That’s my $0.02 anyway (before inflation) :D

  13. Two words come to mind: “Purple Cow.”

    Interesting advice, Ramit–definitely on the edge. I like it. (but I don’t want anyone to confuse “I like it” with “I believe it” or “I agree with it”)

  14. I’m a new college grad-
    What if you’ve maxed out your ROTH IRA’s monthly investment?? And stock options?? What should I invest in?

    By max out, I mean, investing the most without paying taxes.

  15. I’m most appalled to see an “investment advisor” advocating under-30 individuals putting any investment % whatsoever, under any circumstances, in bonds.

    Ramit is correct re: CDs and Bonds, they’re not for non-uber-wealthy under-30s —

    To all the “I keep my savings fund in CDs” investors, you have to set up this equation properly:

    If you were fired tomorrow (that is why we have our “rainy day” fund, in essence, isn’t it?), would you need to cash a not-yet-matured CD? If so, how much interest would the CD be penalized for early withdrawal?

    Then compare the interest earned on the CDs, minus the potential interest loss on your final CD cashed before maturity, and compare it to the interest you would/could have earned in a Savings account.

    Unless you’re quite wealthy or have been saving your rainy day fund for many years (i.e. you’re prob. not under-30), you will likely have barely made more money (potentially even lost money) in laddered CDs after subtracting the pre-maturity interest penalty than if you’d put your rainy day fund into a simple high-yield online Savings account with no withdrawal penalties or fees.

    INGDirect Savings accounts are currently paying 3.0% APY ; new INGDirect 6 & 9-month no-minimum CD’s are currently paying 3.3% APY (12-month CDs are paying… 3.0% APY, go figure). With the interest difference purely negligable, a potential 3-months-of-interest-penalty for early CD withdrawal could well eliminate the “benefit” of ~0.3% interest, especially on 3 and 4-figure sums.

    Splendid site, Ramit! Keep up the good work!

  16. Regina:

    Congrats! You’re doing rather well!

    This probably isn’t the best.. ahem.. forum for answer that kind of question, and it would really help to have more details regarding your current financial portfolio.

    However, as a general rule of thumb, if you’ve exhausted all of your tax-deferred options, feel free to continue with taxable accounts then. Especially if you’re still in the 15% income tax bracket, where your capital gains tax will be minimal…. If not, there are tax-efficient avenues you can pursue such as growth investing if you’re aggressive or muni-bonds if you’re conservative.

    Um, but again, I’d hate to try to give advice without knowing some more details…. It also really depends on where you stand relative to the rest of your portfolio.

    Again, that’s my $0.02 worth from the peanut gallery. I’m not Ramit. :D

  17. Hahaha, the pic is hilarious. I would say that you are right in him going with his Roth IRA. Even though i’m young, i’m still aiming to allocate 20% into bonds. I know it’s a Textbook method, but it will help me sleep a little easier at night.

  18. This reminds me of some cocky know-it-all financial kid I had in a math class recently. He was like, “yeah, bonds are a great investment for young people.” I argued that index funds were probably a better choice long-term.

    He also disagreed with me when I said you can withdraw your original investment from a Roth IRA if needed without penalty. He was like, “trust me I know this stuff. You can’t do that.” He then went to Wikipedia on his phone to “show me,” only to find out that he was wrong. I just gave a little smile and left it at that. :)

    I bet he still thinks bonds are better too…

  19. Ramit, I have been faithfully following your blog for quite some time now. I’m a recent graduate with a student loan and credit card debt and just starting out on a new job. Your blog was the first place that got me started on taking care of finances after school. Thanks for your inputs.

    I would love to hear from you/ or read a post on your favorite brokerage firm and why you prefer them. Thanks.

  20. I’m glad you’re in to the whole “perfect is the enemy of the good” ideology. But writing off bonds because we’re wrong and people don’t understand them is ridiculous. If simplicy is your goal, tell your readers to invest in target retirement funds. It’s one fund, so it’s just as easy as, say, an SP500 index fund, but you’re actually diversified across asset classes and countries.

    FOR YOUR IRA, IF YOU ONLY BUY ONE FUND, BUY A CHEAP TARGET RETIREMENT FUND.

    ekrabs, i bonds pay 0% “real”. They still pay inflation at over 4%, which is better than almost any other option right now.

  21. The key point in this question is that this 3k is the “little money she has saved” just out of college.

    This money should be kept liquid as an emergency fund. Online savings accounts are great for this (they have higher interest rates than CDs, no penalties, and no minimums).

    Then she should open a Roth IRA, and fund at least a small amount monthly to get started.

  22. So your argument against CDs is that they are so difficult to understand, they discourage people from investing all together and therefore should be avoided? Instead open a brokerage account and invest in the those less confusing securities, like mutual funds, ETFs, and stocks? Please, enlighten me.

  23. Jonathan: Or…a lifecycle (aka target-date) fund? It’s the only investment you need to get started.

  24. You would rather someone go into a target-date fund (with it’s fees) for simplicity? Fidelity has got to be loving you. I agree that youngsters should focus on equities for the most part, but to not buy fixed-income investments for short-term goals and as a guaranteed return when markets drop and low positions make liquidity a bit tight is irresponsible. A few years ago, my 20-something friends were all into equities. Now, a lot more of them are very happy with boring fixed-income and non-volatile preferred stock. It takes getting burned only once to change your tune.

  25. Rusty, I hate fees. Many of the best firms (Vanguard, TIAA Cref, Fidelity, etc) have extremely low-cost funds. As for your friends, if they were investing in equities for the short-term, that was a mistake.

    In a technical sense, there’s no problem investing in fixed income for short-term investments (1-5 years), but for most people, an online high-interest savings account simplifies their life and provides comparable results.

    Go try explaining what “fixed-income investments” are to a random co-worker and you’ll see what I mean. Their eyes will glaze over in 30 seconds.

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  28. Hey Ramit im only 17 n got 2 more months till ill b 18. N most of this stuff is very fucking confusing 2 me but i want 2 learn it cuz as soon as i turn 18 i plan 2 put money in2 some kind of investment. The problem is i dont have much money at all i just want 2 get started right away 2 start making money n hope i can get in2 the bigger bucks from their. So if u would please help me out n let me know what would be my best investment 2 start off with 2 get me 2 the big bucks the fastest? idc if its confusing cuz ill learn all i need 2, 2 no what im doing 2 get their. So can u give me your best advise 4 me 2 do this? n make something of my life?

  29. I’m 59 1/2 and my 401k is in the dumps, can I cash it out and put the money in cd’s without a penalty?

  30. How can a CD be bad? You cannot loose money with a CD however with stocks, mutual funds, etc. we have all seen what happened in 2008. Sure stocks go up but they also go down and the fees and complexity of stocks make them a challenge for the average person.

    A CD however is SO EASY to invest in.

    If I had $800,000 today, I would invest all of it into a Single 4% 1 year CD. Then I would just sit back and collect my $32,000 guaranteed profit in 1 year when it comes due.

    Then, after collecting my check for $32,000 I would simply shop around and reinvest the original $800,000 into another 1 year CD with a good (4% or higher) rate of return for another year.

    I would then (with a massive smile on my face) live off the $32,000 for the year, budgeting to make it last.

    I could EASILY live off $32,000 a year in my area and my living situation. Sure, there would be some income tax on that but no more than with a regular job.

    HOW could life get any easier??

  31. Because many people don’t just want investing to be “easy,” they want to make as much money as possible. CDs are nice and secure, but over the long run, equities provide far higher returns.