The lesser of two evils?


Ramit Seth of I Will Teach You To Be Rich recently arose from his bunker – where he has been holed up, busy polishing the manuscript to his latest book [publishers please!] to pose the question:

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

The post was brief, and to the point:

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…

It was the last line that triggered the most comments … and, of course those comments were split into four camps:

1. Pro-CD’s

2. Pro-Bonds

3. A little of both

4. Ramit, why don’t you write more 😉

But, these miss the point …

Are you an ACTIVE investor or a PASSIVE investor?

Active Investor

You will have realized that you can’t retire on $1,000,000 in 15 to 20 years. And, inflation will serve to ensure that investing greatly in either Bonds or CD’s will keep you poor.

Therefore, you will be looking for direct (maybe leveraged through margin borrowing, if you have the ‘appetite’) investments in a very few stocks that you understand and love, a business here or there if you have the aptitude and interest, and/or a few well-chosen real-estate investments.

You will manage these for growth and hold until they no longer make sense to keep, or you retire (and, want to adjust your investment strategy).

I don’t see any room in this portfolio for either CD’s or Bonds, except as short-term vehicles for parking cash while you gear up for the ‘next big thing’ do you?

Passive Investor

OK, so we don’t all want to be rich … and some of you are just window-shopping this blog (or, seeing how the ‘other half’ lives?).

Let’s say that you DO subscribe to the $1,000,000 (or even $2,000,000) in 15 – 20 year philosophy (yes, I even had some applicants for my 7 Millionaires … In Training! ‘experiment’ with that outlook … they don’t need my training; they just need Valium!) … what then?

Firstly, you will be looking to max out your 401k/ROTH certainly enough for the full employer-match; this will probably mean selecting from the list of funds available … unlikely to include Bonds (although, there may be a Bond Fund in there, somewhere) and certainly CD’s won’t be an option. So, it’s a moot point.

Secondly, you will probably be looking to invest in buying a home … saving a deposit, making payments, etc. then trading up as soon as the sun starts to shine (now, there’s a financial treadmill for you!). So, it’s a moot point.

But, Uncle Harry might die and leave you with $20,000 and you are suddenly faced with the decision: CD’s or Bonds …

…. hah, you think you got me? No way!

I would be immediately looking at becoming an Active Investor ($20k might just be enough for a deposit on that nice little rental ‘fixer upper’ down the street).

But, let’s say that you still are determined to retire late and poor … but, don’t want to be quite so poor … where would I go for advice on conservatively investing that nice little chunk of change?

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 a few weeks ago.

At the meeting, Warren suggested that IF you don’t really know what you’re doing, 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).


Well inflation will keep your CD’s and Bonds 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 averaged an 8% return) and you will stand a better chance to beat inflation …

Of course, none of these PASSIVE investment strategies will make you rich (or even financially free at a young age), but Warren’s strategy at least has a better chance of keeping you out of the poor house, and giving you a chance of retiring at 55 or 65 … IF you start young enough, and maintain the course for 20+ years!

But, what if you don’t want to invest in stocks at all … even via an ultra-low-cost Index Fund? Is it thenOK to invest in Bonds or CD’s?

Maybe, but I would much rather plonk that $20k into my mortgage!

I know that I said that it’s a dumb strategy, but it’s sure better than the CD/Bond alternative (better after-tax returns, but check with your financial adviser before doing anything!).

In fact, the only time that I would invest in:

1. CD’s – when I need to ‘park’ some money for a while … waiting for the next ideal investment to come along.

2. Bonds – when I am already rich and retired: Bonds can play an important part in maintaining wealth as part of a Making Money 301 strategy. As Ramit mentions in his comments, Bonds can be laddered (that means bought with a variety of expiry/cash-out dates).

For two great Bonds-in-Retirement strategies, read: Worry Free Investing by Zvi Bodie and The Grangaard Strategy by Paul Grangaard.

Now, let’s go and get rich!

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5 thoughts on “The lesser of two evils?

  1. A picture is worth 1000 words. I’ve had to talk a handful of close friends (recent graduates) out of the CD “investing” route. It is amazing how many people think CDs and bonds are part of the path to wealth at a young age.

  2. Even inflation indexed products are a bad investment – I really fail to see why people think that TIPS etc make good investments (even when inflation is rising)?

    The only time I would invest in bonds is if was expecting a meaningful decline in interest rates. Even then a market when interest rates are falling is likely to provide even better opportunities in equities and real estate.

  3. @ Trainee – The one time that they MIGHT make sense is when you have ‘just enough’ capital to fund your current annual retirement expense at (say) a couple of percent interest rate (which is what TIPS tend to average out to). Then the TIPS (or Inflation-Protected MUNI’s) take away the one factor (besides mismanagement of your spending) that can eat away at your retirement ‘salary’: inflation!

  4. Pingback: Inspiration at the pump …- 7million7years

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