Certificates of deposit (CDs) are extremely popular right now. Understandably so, since some top CDs pay APYs of higher than 5%. As such, you might assume they'd be a good way to build wealth. After all, those high savings rates are guaranteed for the CD term, and CDs are usually FDIC-insured.
Sadly, CDs aren't a magical solution to all things financial. When it comes to growing rich, a lot depends on your situation in life, the state of your emergency savings, and the amount you can put aside each month. But if you want to seriously boost your nest egg, a relatively safe investment like a CD or high-yield savings account will only take you part of the way.
For many people, it may make more sense to buy riskier assets with the potential to generate higher rewards over time. Here are some other routes to consider.
1. Tax-advantaged brokerage accounts
Tax-advantaged retirement accounts like individual retirement accounts (IRAs) and 401(k)s are excellent ways to build up a nest egg. Not only do some 401(k)s benefit from employer matching, but the IRS will also let you either defer taxes on your contributions now or make tax-free withdrawals further down the line.
There are limits on how much you can contribute to an IRA each year, but if you aren't taking advantage of these tax benefits, you're missing out on a significant investment boost. Let's say you're in the 22% tax bracket and put $6,000 into a traditional IRA for 2023. That reduction in your taxable income could save you $1,320. You'd also benefit from any returns the assets in your IRA generate over time.
To be clear, an IRA or 401(k) can hold different asset types. You can even put CDs into some IRAs, though it's more common to include a mix of funds containing stocks or bonds. Also be aware that you may be penalized if you withdraw funds from your IRA or 401(k) before you reach age 59 1/2, so it only makes sense for money you'll use in your golden years.
Here are some steps you can take today to benefit from tax breaks on your retirement contributions:
- Find out whether your company has a 401(k) plan and will match some of your contributions. If so, learn how it works -- particularly the maximum match amount and what assets you can include.
- Understand the different types of IRAs and find out which will work best for you. Broadly speaking, a Roth IRA lets you pay tax today and withdraw tax-free in your retirement. A traditional IRA reduces your tax bill now, but you'll pay taxes on your withdrawals further down the road.
2. ETFs
Exchange-traded funds (ETFs) and index funds are excellent alternatives to CDs, as they have the potential to generate higher rewards over time. Both contain a basket of securities and can diversify your portfolio by including a mix of companies in different industries.
For example, if you bought an ETF or index fund that tracks the S&P 500, it would give you exposure to the largest 500 companies in the U.S. The S&P has generated average returns of over 10% over the past 50 years. No stock market investment is guaranteed, and average returns include years when the market dropped.
ETFs offer a relatively safe way to invest in the stock market. Over time, they will likely beat the APYs on even the best CDs.
3. REITs
REITs, or real estate investment trusts, are a way to invest in real estate without owning property. One reason they're attractive to investors is that they have to pay a certain percentage of their income as dividends. This means you can profit from the regular dividend payments as well as any appreciation in the value of the trust itself.
It's a complicated time for real estate investing, and REITs carry more risk than CDs do. However, REITs are often less volatile than stocks, you can put them in an IRA, and they have performed well historically. They can be a great way to further diversify your portfolio. Plus, where a CD ties you into a set term, there are no limits on buying or selling your REIT.
Key takeaway: Know how to build wealth
If you want to get rich, there's no single "best" asset class. Rather, the question is which asset is best for you, and which combination might help you achieve your financial goals? The following rules of thumb will help you compare investments and strategies:
- Think long term: Historically, buy-and-hold investments can generate decent returns by making consistent investments over time. For many retail investors, a long-term viewpoint can help them wait out short-term market fluctuations and compound their gains.
- Build a diversified portfolio: It's fun to think about the value of, say, CDs vs. the stock market. But you'll find it's often not an either/or scenario -- the trick is to spread your investments around. That means holding different types of assets with exposure to different industries.
- Understand and manage risk: Risk-wise, there's a huge difference between a savings vehicle, an S&P 500 index fund, and buying into a penny stock or cryptocurrency. Higher-risk investments carry the potential for increased returns but could also collapse completely. The right mix will depend on you.
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