Investors wanting to grow their retirement portfolios often turn to certificate of deposits as investment vehicles. But is this a smart move? CDs have been around for years and are a popular investment vehicle, but they are not for everyone. Let’s discuss whether or not they are good retirement investments.
What exactly is a CD?
A certificate of deposit is typically purchased directly from a bank, but can also be offered through a brokerage. Bank CDs are known as traditional CDs. CDs offered through a brokerage are known as brokered CDs. When you purchase a CD you agree to invest your money for a specific period of time and the bank agrees to pay out a specific rate of interest. At the end of the term you get your original investment back plus the interest. Depending on what type of CD it is, you will be charged an early withdrawal penalty if you withdraw a portion or all of your money out before the CD matures. A brokered CD can be sold before the maturity date.
Risks of Certificates of Deposit
There are two main risks when investing in CDs: Inflation and lack of liquidity. If you are going to need your cash fairly soon, then choose a short-term CD or another investment vehicle altogether. Once you invest in a CD your money is tied up for the duration of the term. People who want a safe investment, but need liquidity should consider a money market account.
The other downside of CDs is the low rate of return. Sure they are a low-risk investment, but often times the rate of return does not even keep up with inflation. That means you are actually losing money. Let’s say you invest in a long-term CD while market rates rise, you are actually losing money. To avoid this hazard, investment experts recommend laddering your CDs by investing in multiple CDs with different maturity dates and then reinvesting the funds in higher rate CDs.
Investing in CDs for Retirement
There are two different kinds of investments: Wealth building investments and wealth preserving investments. CDs definitely fall into the wealth preserving category. So investing in CDs for retirement really depends on what your goals are.
A young person who has several years of work before retirement will want to build wealth by investing in higher risk/higher return investments like stocks. Stocks have been proven to be the best long-term wealth building vehicle for young investors to build retirement. That means they will want to avoid CDs for the most part. A young investor may want to park some cash in a CD for a short period of time and use it as a temporary savings account for a down payment on a house.
Older investors who are close to retirement or have already retired may want to use CDs to mitigate risk and preserve their existing wealth. If you are close to retirement then it isn’t a bad idea to adjust your investment portfolio and move funds from higher risk vehicles to CDs. Remember, CDs are FDIC insured so even if the bank goes under your investment is still protected.
The Final Word on CDs for Retirement
For most retirement investors, CDs are not the answer to building a secure future because the returns are so low. Other investment vehicles offering a greater return are a better option. CDs protect capital, but they are certainly not income generating investments. If you keep this in mind you will know when a CD may be an appropriate investment choice. Should you have questions you should speak to an investment expert or financial planner.