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

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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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  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!?