Friday, August 08, 2008

CD IRAs - a Really Bad Idea

Last week I visited my local branch of Bank of America where I saw a large poster advertising "high rates" on CD IRAs - a high rate being an APY of 3.3%. On their website, BoA says that this product is for "People who want to take the guess work out of investing while enjoying the peace of mind of a steady high yield return." My take on the issue is that unless you are in your 60s and are approaching your retirement years, investing in a CD IRA strike me as a really bad idea. Even in such cases, investing your long term savings in a CD is a dangerous game.

When investing for retirement, many folks worry about taking excessive risk. They are concerned that their investments will tank and that they will lose their retirement savings at a time when they are unable to work. However, reality is that with a long investment horizon, the biggest investment risk one can take is to invest in a way that will not allow your investments to outpace inflation.

While in recent years inflation has been relatively benign, there have been a number of periods historically where the U.S. has seen considerably faster price increases. Check out this chart on Wikipedia. But forget historical inflationary break-outs, at 3.3% APY the yield BoA is offering does not even keep pace with the current pace of expected inflation. This means that while you are thinking you are saving for retirement by contributing to this so-called high-yield CD IRA, the money you are putting aside purchases less and less every year.

Although it may be counter-intuitive for some, if you are planning to save for retirement (or for another long term goal, for that matter), investing in a well balanced portfolio of index funds, which includes both stocks and bonds, is a much safer way to go. Inflation is the quiet killer of low yield "safe" portfolios. Don't be fooled.

I have written in the past about how to build a portfolio, if you are interested take a look at this topic in more detail (or simply select the "investing" category in the left column on this page).


Morgan said...

My wife and I have a few CD IRAs from ING Direct. We know that they are a bad choice, but they're our best choice for the moment (we think). We're currently saving for a Vanguard mutual fund. The CD IRAs are a way to earn a little bit more interest than simply leaving our money in a savings account while we wait. The CDs are set to mature right about the time we expect to have enough money saved up for some real investing.

Shadox said...

Well - as long as this is a temporary measure this is obviously a good idea. However, I suspect that most people who use CD IRAs do so as a form of long term retirement savings - which is a really bad idea in my opinion.

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