Using certificates of deposit to save for retirement when you're in your 20s is a little bit like taking a cross-country road trip on a Segway two-wheeler. Sure, you may get where you're going eventually, but it's going to take a heck of a lot longer, and it won't be the least bit comfortable.
But despite CD rates being at historic lows, lots of 20-somethings think CDs are a great way to save for retirement, according to a recent survey on behalf of Wells Fargo Bank of 1,800 people conducted from July 9 to Sept. 7.
In the survey, respondents were asked how they would invest $5,000 for their retirement. Overall, 40 percent said they'd put the money into a savings account or a CD, and 24 percent said they'd invest it in stocks or mutual funds. But, when it came to those ages 25 to 29, nearly half said they'd put the money in a savings account or CD, while just 18 percent said they'd put the money into stocks or mutual funds.
Here's the thing: Using CDs to save for retirement is a terrible idea if you're that young. Over the long term, returns on CDs barely keep up with inflation. Even in the best-case scenario, at the end of the 30- or 40-year period when today's young people will be saving for retirement, the money they sock away in CDs will buy just a little bit more stuff than it would when they deposited it. Most people simply won't be able to save enough that way to finance a retirement that may last 20 years or more.
I don't really blame the under-30 crowd for being attracted to the idea of risk-free investments. If you came of age in the mid-2000s, your view of the market so far is of a once-in-a-generation financial crisis and an uneven recovery when stocks have essentially moved sideways.
But the stock market's' recent dismal performance hasn't been the case over the long term. To illustrate, I ran some calculations using Bankrate's CD data and historical stock data provided by CentralTendencies.com.
If you had deposited $5,000 in a one-year CD back in 1984 when Bankrate first started collecting data on CD yields and kept rolling the principal and dividends over until now, you'd have $12,272.29 sitting in your account today. Meanwhile, if you'd put the same amount in the Standard & Poor's 500 index, which includes the top 500 biggest U.S. stocks, and reinvested the dividends, you'd have $71,381.47.
While past performance is no guarantee of future results, there's a good chance that if you invest $5,000 in an S&P 500 index fund, you'll end up with a lot more money to blow on RVs and early bird specials than you would if you put the same amount in CDs.
What do you think? Are CDs a good way for young workers to save for retirement? What do you use CDs for?
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