Is it better to invest in an IRA or a CD?
Investing for your future is almost always a wise long-term financial move. After all, the decisions you make today will have an impact on how financially stable you are tomorrow.
When you start investing, you'll learn that there are several investment vehicles to choose from. And if you're like most investors, you'll end up with a diversified portfolio that's inclusive of multiple asset classes.
But what about individual retirement accounts (IRAs) and certificates of deposit (CDs)? If you have money available to invest and you want to put it to work for you, which is the better option? Ultimately, the better option for you depends on what you plan to get out of your investment.
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Is it better to invest in an IRA or a CD?
"You can invest in both and make your CD your IRA," says Joel Russo, owner and retirement advisor at NJ Retirement Planning. "You can make just about anything your IRA; for example, your CD, mutual fund, annuity, brokerage account, etc."
"Better is not fair," Russo says. "It depends on what you're trying to accomplish. Risk tolerance, time frame and contribution amount all need consideration."
In other words, whether an IRA or a standalone CD is better for you depends on a range of factors.
When it's better to invest in a CD
One of the most important factors to consider is time. When you invest in an IRA, you're making a retirement investment and will likely be penalized if you access your money before you're 59 ½ years old.
So, if you need your money before you retire, a standalone CD is likely your better option. After all, with a CD, you only lock up your money for the term of the account, which typically ranges from a few months to 10 years.
A CD may be the better option even if you have a long-term investment horizon. For example, let's say you plan on taking the vacation of a lifetime in 10 years and need a safe place to store the money to earn a meaningful return as you wait. If that 10-year mark happens before you turn 59 ½, a 10-year CD is probably going to be the better option to save for this goal.
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When it's better to invest in an IRA
An IRA can also make sense in multiple situations. A few times when it may make more sense to use an IRA include:
- To save for retirement: An IRA is a retirement account. So, if you're saving for your retirement, this is likely the better home for your money. Early access penalties help bring discipline to your retirement savings while long-term holdings typically benefit from the power of compounding returns in the market.
- To reduce your income tax burden: When you make investments in your IRA, you'll usually do so on a pre-tax basis. This means your taxable income is reduced by the total amount of your contributions. That could result in significant savings when tax time comes around.
- You need flexibility: As Russo pointed out above, you can hold a wide range of investment vehicles in your IRA. You can even use a CD as part of your IRA. However, you also have access to the stock market, bonds, mutual funds and other investment opportunities. On the other hand, you don't necessarily need an IRA to access these other assets. You can do this through your traditional brokerage account as well.
Why it may be best to use both
Many investors can benefit from having taxable and tax-advantaged investments. As such, most investors may want to consider putting money into these investment vehicles. After all, saving for retirement is important and IRAs give you a tax-advantaged way to do so.
And, big expenses happen from time to time and you'll likely want to save for them as well. For example, you may need to save for a down payment on a home, a dream vacation or a new car. In most cases, you'll likely need to access your money before you retire, so a CD would be the better option.
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The bottom line
IRAs and CDs are both useful financial tools. As a result, chances are that you can benefit from putting money in both of them. In turn, you may want to consider opening a CD to earn more while you save for short-term expenses and using an IRA to benefit from tax advantages while you save for retirement.
