When it comes to your retirement savings, understanding different account options, their fees, and the risks involved is key to your long-term success. Two relatively safe options that many retirees rely on are certificates of deposit (CDs) and mutual funds.
So which option is better for you? That depends on your savings timeline and risk tolerance. Read on for a breakdown of CDs vs. mutual funds so you can make an informed decision with your money.
What is a certificate of deposit (CD)?
A CD is a type of bank account you can open with most banks and credit unions. It allows you to deposit a lump sum of cash, and in return, earn a fixed interest rate on the balance. However, you must agree to keep your money on deposit for a certain amount of time, known as the CD’s term. Typically, banks offer terms between three months and five years, though it’s possible to find longer- and shorter-term CDS. If you withdraw your funds before the maturity date, you’ll have to pay a penalty.
CD rates tend to be significantly higher than those offered on traditional savings accounts, so they can be good options for growing your money. Plus, your deposit is protected up to $250,000 as long as you open an account with an FDIC-insured bank or NCUA-insured credit union.
What is a mutual fund?
A mutual fund is a type of investment security. With a mutual fund, you invest in the fund through a brokerage firm; the investment firm pools your money with investments from other people to buy a diversified portfolio of stocks, bonds, or other securities. The fund's investment portfolio and allocation — how much is invested in each company or security — is handled by the fund manager.
A mutual fund is less risky than investing in individual stocks since you're investing in a variety of companies at once. If one company performs poorly, the idea is that the performance of the other stocks within the fund can offset the losses.
Mutual funds have the potential for much higher returns than CDs and other deposit accounts can offer. However, those returns aren't a guarantee; market fluctuations can cause prices to dip, and you could lose money. Plus, mutual funds involve fees. which can eat into your earnings.
Mutual funds vs. CDs: Key differences
Although both CDs and mutual funds can be useful tools as you save for your retirement, there are several major differences to keep in mind.
Fees
In general, mutual funds have more fees than CDs. With a CD, you only have to worry about the early withdrawal penalty — which you can avoid by leaving your money untouched until the CD's maturity date.
Mutual funds are quite different, as they involve operating expenses (the fund's expense ratio) and commissions.
Liquidity
Mutual funds are usually more liquid than CDs. With a CD, you have early withdrawal penalties that reduce the amount of interest you earn. By contrast, you can sell a mutual fund whenever you wish. If your money is in a taxable brokerage account, you can withdraw money after selling a mutual fund without penalty.
Risk
CDs and mutual funds are lower-risk options than investing in individual stocks. However, there is still some risk with either option.
With a mutual fund, there is the risk of market changes. If the holdings in your fund perform poorly, you could lose money.
With CDs, your principal balance won’t lose value. However, there is inflation risk, meaning the interest rate you earn on the CD may not be high enough to outpace inflation, so you effectively lose money.
CD vs. mutual fund: Which is best for you?
Now that you know the key details of a CD vs. mutual fund, you can decide where to put your money. Which option is better for you is dependent on your timeline and the level of risk you're comfortable taking on.
You have an investing timeline of five years or less: CD
If you're investing with a shorter time horizon — for example, if you're saving for a down payment on a house or are planning to retire within a few years — a CD is likely the better choice.
With such a short timeline, you can't afford to lose money and wait out a market recovery, so the focus is on protecting your money with a modest return. A CD will earn a fixed rate of interest, giving you predictable growth.
You're saving for a long-term goal: Mutual fund
If you have more time to reach your goal — for instance, if you're in your 20s or 30s and are saving for retirement — mutual funds are a wiser choice than CDs. You can afford to take on more risk for the potential of higher returns since you have time for the market to recover from any downturns. Historically, the stock market has delivered higher returns than the interest rate you'd earn on a CD, so mutual funds are a better option for long-term investing.
If you need help choosing an investment or account type, set up a consultation with a financial advisor. They will review your finances, discuss your goals with you, and develop a plan to help you achieve them.
source: finance.yahoo.com
