When I spoke at DisplayMax's Annual Summit in January, Tim asked me if it's better to invest in CDs or a 401(k). My standard answer is, "It depends."
Investments were difficult for me to understand for a long time. Phil has more knowledge than I do, though.
We answer Tim's question on today's podcast episode. We also talk about other types of investments.
When I spoke at DisplayMax's Annual Summit in January, Tim asked me if it's better to invest in CDs or a 401(k). My standard answer is, "It depends."
Investments were difficult for me to understand for a long time. Phil has more knowledge than I do, though.
We answer Tim's question on today's podcast episode. We also talk about other types of investments.
Hi Tim, Thank you for joining me today. What financial question or topic would you like us to discuss on our podcast?
Speaker 2:I would like to know what's a safer investment CDs or 401k?
Speaker 1:All right, we'll make sure we talk about that, thank you.
Speaker 2:This is Life, love, money with Dr Angela K Love, the podcast for couples who want to get a handle on their finances and strengthen their marriage at the same time. We take deep dives into the money challenges most married couples face and get real about them, Plus practical tips on how to ensure a rock-solid future for your money and your marriage Now, dr Angela K Love.
Speaker 3:So we just got back from taking our pig to the processor and this one was a really big pain in the keister in getting him into the trailer. But boy is he going to taste good.
Speaker 1:We didn't have any problems getting him out of the trailer. He was like get me out of this thing, because he had been in there for several days and we opened that up and he didn't care about that. It was like about a foot drop. He was just I want out of here.
Speaker 3:So that was nice, that's true. So why do we have been there so long?
Speaker 1:because of the rain, the rain, yes, we had tons of rain, and on our property where we have the pigs located, it becomes a swampy mess and you can't get a truck in and out. And today was the day we had scheduled to take him to the processor, so we had to put him in early, before all the rain came. And we got quite a bit of rain. How much did we get?
Speaker 3:Nine and a quarter inches in two storms in the past two weeks.
Speaker 1:That is a lot of rain, a lot of rain, a lot of rain. It's like a swamp I'm expecting alligators to come up anytime yep, but we don't have alligators this far north in texas, I don't think they do if we go further south true, true, I actually I don't know. We haven't lived in texas long enough and I've never really asked.
Speaker 3:You know, we know we've seen them because we've watched episodes of lone star law. True, they have to man manhandle the allocators that's true.
Speaker 1:We have watched that show. That's a fun show to watch. Well, the topic today is Tim asked the question which is better to invest in, either a CD or a 401k, and I was thinking that first we should probably explain the difference between those two, what those are.
Speaker 3:That's a great place to start. So what's a CD?
Speaker 1:CD is a certificate of deposit. Anyone can go to their financial institution that's offering that and they can invest in a certificate of deposit and you can with those. You can get them different number of months, it just depends. So they pay different interest rates on however many months you want to put your money into that, and they're typically 18, 24, 36, 48, and 60 months, but it can vary depending on the finance institution and what they're offering.
Speaker 3:So is there a big difference from one institution to another and what rate they might be offering on the CD?
Speaker 1:It could be. It depends on what's going on with the institution and what they're trying to do. If they're trying to get more funds into their institution, they'll probably raise the interest rate, and if they're not looking for people to invest in their institution, they'll lower those interest rates.
Speaker 3:Okay. So if you put money into a CD for 18 months and you have to take it out nine months into it, is there a problem with that?
Speaker 1:I don't know that you pay a penalty, but you lose all the interest that you earned.
Speaker 3:So some of them used to have where you had to pay a penalty too, so I guess it just varies.
Speaker 1:I think it varies on the financial institution. Sometimes they do have you pay a penalty, plus you lose all the interest, and some say you're just going to lose all the interest. So when you go to do that, you don't want to put your money into something and lose out on that money, so you want to make sure that, if you're going to put the money into the CD, to go ahead and do that. One thing that can help with that, though, is what's called laddering your CDs, and that's where you would start off with maybe, an 18 month CD. You put your money in there, and then you wait three months, and then you do a 24 month CD or another 18 month CD. I mean, you can just decide, and so what happens is is, once you get them all established, they mature based on however you set those up.
Speaker 1:So if you set up an 18 month in January and then you set up another 18 month in, let's say, march, then in 18 months, you'd have the first one that would mature, and then, three months later, you'd have the next one mature. So you can just kind of decide how you want to do that, so you could split up your funds, because some of them the longer, depending on how long it's in there, that can also affect how much they're paying on the interest rate. So a CD that has a longer term could pay a higher interest rate. But if you're like, well, I don't want to really tie up all of my money, let's say if you have $10,000 and you're like I don't want to tie up all of my money for 36 months, you could split that into where you do one CD that's 18 months for $5,000, and another one three months later, you know, for the 36 months, or you could do them at the same time. So that's what a CD is.
Speaker 3:Okay.
Speaker 1:So why don't you explain what a 401k is?
Speaker 3:Well, a 401k is a retirement plan, usually offered by wherever you work. Some cases, if you work for a nonprofit, it might be like a 403B or something like that. But usually the money goes into a 401k before taxes. So it comes out of your pay, goes in there before taxes and the thought is that it saves money for retirement. So later on down the road, when you're retired, you start drawing money out of that, and when you draw the money out you might be at a lower tax bracket than what you are now.
Speaker 1:So what are some other types of investment? So I know we're talking about CDs versus 401k, but there are some other types of investments, such as annuities.
Speaker 3:Yeah, annuity Annuities, investment with an insurance company. It's kind of like a CD with an insurance company. It's a real rough way to describe it. You know that they have there.
Speaker 1:Is it on term, like number of months, like a CD?
Speaker 3:Usually it's longer than what you would see with the CD. You know years and stuff like that. You know years and stuff like that. And then, of course, you have stocks, which is investing in companies you know that have already have their. You know they've done a public offering and they've gotten the money from the initial sale of the stock. So you're usually buying stock from somebody else that has the stock or mutual funds, which could be a combination of stocks or bonds, and bonds is basically investing in a debt instrument of an institution or company or the US government or something like that. You have a lot of different. You know investment vehicles, real estate. You know a lot of people will do that.
Speaker 1:Those are called REITs right Real estate investment.
Speaker 3:Or just investing in the straight buying, you know, an apartment building or something on their own, Sure.
Speaker 1:And then in the stock market are there different types of stock markets.
Speaker 3:Yeah, there's different markets and there's different things on the market itself.
Speaker 1:So what are the different types of stock markets?
Speaker 3:Well, there's different exchanges.
Speaker 3:You have here in our country the main ones in New New York Stock Exchange, but you have stock exchanges all over the world where things are traded, and also we have the American Stock Exchange and we have the over-the-counter exchange. So those are just markets that are helping set prices. And the thing that's different now than what it was when years ago we were there growing up is that stocks trade all the time, so you can go into your brokerage account and can actually buy stock at 2 in the morning if you wanted to, or put an order in on that. And then there's all kinds of other things based off stocks, like options and commodities futures. So you have all kinds of different investments that are there.
Speaker 3:The 401k typically it's going to be offered by your employer and it's usually voluntary if you want to participate in it or not, but the money in that is designed to be used for retirement. So, whereas you might put some money in a CD and you want to use it, you know, a year, 18 months, three years down the road, your retirement may be further down the road than that.
Speaker 1:True. And then the thing that's not really talked about with 401ks, that some may not understand, is that a 401k just by itself I mean there's different types of investments within that 401k 401k just all by itself is not like an investment. It's just where you put your money in and then whoever's managing that 401k? They're investing into different things. Maybe it might be mutual funds, it could be stocks, it could be CDs right?
Speaker 3:Most 401ks they're going to invest in some sort of a mutual fund. Which mutual fund basically is like a company that's buying a bunch of different type of stocks and sometimes they'll have money as cash they're holding and sometimes bonds, so they're buying that in the fund and when you buy a piece of that fund you're kind of getting a blended return on what all that stuff's doing. You know that's there. So your employer usually they'll go with some company that will manage the 401k and they usually have a whole series of funds that you could choose from.
Speaker 3:A good 401k is going to have some funds that are tied just basically to the performance of the market, maybe what they call large cap funds, which might be big companies that are well like IBM and Coca-Cola and Apple and stuff like that, and then they might have some that are medium sized companies, you know, with them growing, maybe small companies, and you know then they'll have some other options different funds of different sectors, funds, different funds of different sectors.
Speaker 3:Maybe you have one that invest in energy companies, you know, or maybe one that invest in telecommunications or computers, and ideally I think a good 401k should also have a money market fund which is kind of like kind of like a cd a little bit, except you don't have that commitment on the time, because if you are real concerned on the stock market and you're in a 401k, you would have the ability to move that to you know, money market fund where it would be safer from the stock market going down in value now one thing, a little bit of history, and you correct me if I'm wrong, but back when we were graduating from high school, going into college and having jobs and that sort of thing and this is back in the mid to late 90s or mid to late 80s rather, if you had a 401k with your employer, they didn't let you go in and make changes because we didn't have the internet.
Speaker 1:So you couldn't really go in and select where you wanted to place your money and what percentage you know, and which different types of investment vehicles within that 401k. But today most companies will allow you to do that. They'll give you some options and some companies will give you a lot more choices and some companies give you just a few choices.
Speaker 3:Well, a lot of them when we were younger. They didn't really have 401ks as much as they had a pension plan.
Speaker 1:That's true.
Speaker 3:Or a defined benefit plan and basically the difference is the defined benefit plan is trying to give you a certain income each month after you retire, Whereas the 401k is kind of like it's defining how much is being contributed into the plan and you're not necessarily guaranteed that I'm going to get a certain amount of income out of it. So that's a big thing. I think that's changed. A lot of employers have moved away from the pension plan into a 401k because there's just so much uncertainty with the pension plans being adequately funded. You know we have. We used to live in South Dakota and the state of South Dakota is one of the few states that has a pension fund for their state employees that's completely funded, Whereas if you go to like California, you know the state of California come up from people who have paid in or who are eligible for stuff in the pension fund.
Speaker 1:That's if everybody decided to retire today.
Speaker 3:Yeah, right, if everybody decided to retire today. So I mean the important thing. The 401k is a vehicle that helps you with retirement and there's tax advantages to it. A CD is not really probably going to be part of a 401k, but you could use a CD for other types of tax-advantaged type investments, like an IRA, individual retirement account or a self-directed IRA. Some of those funds could be put in a CD and there you're still earning interest, but that money would not be taxable to you as interest until you begin to draw it out later on down the road. There is a penalty. If you're drawing out the money before you're, I think, 55, there's an extra 10% penalty on it, that's on the IRA.
Speaker 3:That'd be on the IRA. That'd also be on the 401k as well. And when you draw out money on the 401k, you have to pay income tax on the entire amount because that money was taken out prior to taxes.
Speaker 1:The entire amount that you withdraw, not necessarily the entire amount that you have invested. So if you had $100,000 in there and you decided to take out $40,000,. You would pay the taxes and the penalty on that $40,000.
Speaker 3:Yeah, exactly, that's kind of how that part would work. But most employers who have a 401k plan will have an option for you to borrow money against the 401k. Some of them are limited to situations of hardship. You know, if you had somebody in your family that lost a job, or you're sending a kid to college and you needed money, or you're buying a house and then you're basically paying interest back when you're making payments on that. Usually you're deducted from your paycheck and you're buying a house and then you're basically paying interest back when you're making payments on that. Usually you deduct it from your paycheck and you're kind of paying yourself back.
Speaker 1:Well, the interest is, you're paying interest, but that interest goes into your account, so you're paying yourself back on both of those.
Speaker 3:Yeah, exactly.
Speaker 1:You're paying back the part of the principal that you borrowed and then you're paying interest on that, but it goes all back into your account.
Speaker 3:Yep, the key thing on the 401k is a lot of companies will match monies that you put into the 401k to encourage you to put money in.
Speaker 1:And we've talked about that on a previous podcast episode. We talked about how the employer, if there's an employee match or employer match rather, that you'd want to take full advantage of that.
Speaker 3:Sure. So my employer matches 100% of the first 3% you put in and then 50% on the next two. So for every 5% I put in, 4% of that is going in from the employer. So if I didn't put any money into the 401k that would be like leaving 4% on the table.
Speaker 1:Right and you don't want to do that. If you can avoid it, I mean, you want to do that, you want to get that employer match.
Speaker 3:Yeah.
Speaker 1:So, if at all possible, you know, take advantage of that. So when Tim asked the question, which is better, a CD or a 401k, it really comes down to what are your goals, because a 401k is typically used for retirement and CDs are used for investment, which you could use that money for retirement. You could, you know, if you're getting a really nice return sometimes.
Speaker 3:Like an IRA Right Individual retirement account.
Speaker 1:Sure you could do that or sometimes just the CD. I mean, I've seen them at 5% before in certain situations I think Was it during COVID or right after things started to get back to normal. There were some financial institutions that had CDs at 5%.
Speaker 3:Some of them have it there now.
Speaker 1:Oh, do they? Okay, I haven't looked recently.
Speaker 3:Yeah, liquidity is tight in the banking industry and so you know what banks are going to try to do in credit unions is to take deposits and turn around and make loans with them and then they kind of make money on the difference between what's being paid on the loans versus the deposits. So if an institution thinks they're kind of in a crunch or something like that, they need some more liquidity or they got a lot of new loan demand out there, they may offer some special CD rates in order to try to get that money in.
Speaker 1:So you were saying that, for example, mortgage loans right now are over 7%. So we'll just say 7.5, because I don't know where they're at. And if they're paying 5% on a CD, then and they're loaning out the money that they get from the CD, if they turn around and loan that out on a mortgage, they're essentially making two and a half percent.
Speaker 3:Yeah, I mean that would be the difference on that. Now the challenge on the mortgage stuff is most institutions don't hold the mortgages on their books. I mean some smaller ones do. Sure, and duration risk is the risk that you have of investing money into something that has a fixed rate of return, a certain percent a year, and then in the future interest rates going up to where that percent you're getting is no longer adequate.
Speaker 3:So if you did that, if the bank said, ok, I'm going to give you a CD for 5% for two years, and then they turn out and put the money in a mortgage at 7%, for, let's say, they lock that 7% in for 30 years, then if two years passes and the interest rate environment goes higher, maybe they need that money again. So they're offering you a deal now. Maybe they're giving you 6.5%. So instead of making their 2% spread with that mortgage still being in place now, they're only making 0.5%. In some cases it goes underwater. When you have a ton of those that happen in an institution, you begin to have liquidity problems and you have bank failures and we've seen that before.
Speaker 1:So, in response to Tim's question, it really just depends on what his goal is.
Speaker 3:That's the response to most financial questions.
Speaker 1:What is your goal? It depends, what is your goal.
Speaker 3:Because the money is there for two different reasons, you know. One of them is retirement and it's saving money for long term down the road and the CDs could be used as a retirement like an individual retirement account. But most of the time it's not, it's just used to make some. You know I got some extra money here that you know. I want to make a little better interest rate on than what I'm being paid for in my checking account, so I'm going to move it over to a CD.
Speaker 1:Right. Or like if you had money in a money market account or a savings account that's making 0.3% and you don't plan on spending that money in the next year or 18 months, you could go put it in a CD, make 5%, and now you've made a higher rate of return on your savings Because that could be money that you're like okay, I don't want to tie it up in IRA, I don't want to tie this money up. You know I don't want to tie it up. I want to be able to have access to it. But I know I'm not going to have need access to it for the next 12 months or 18 months. So I'm going to go ahead and put it over here.
Speaker 1:You know, maybe you don't want to put it in the stock market, maybe you're really risk adverse. So you're like I don't want to take a chance at losing money and I want to have to fiddle with putting it in there and pulling it out and doing all that kind of stuff. So I'll just go put it in a CD because I know I'm not going to need it. And that's where laddering comes in with the CDs is. Maybe, you know, you're not going to need a certain amount for 12, you know, for 18 months. But you want part of it in 12 months so you can put the dollar amount that you need that you know you're going to need in 12 months and put that in one. So you know, you're okay, I'm going to make money on that. You know, 5% on that amount in the 12 months. But this other portion, I know I'm not going to need that for 18 months, so I'll just go ahead and put that into an 18 month CD and make 5% on that.
Speaker 3:Yeah, that makes complete sense if they want to do that. Or they may leave some in a CD and take some in some other investment too.
Speaker 1:Right, and there's some folks. What they do is they'll put the money into a CD for 12 months or 18 months or 24, whatever it is that they're doing and then, when that matures, they just turn around and roll it back into another CD. They take the money that they originally put into that CD, plus the interest that they earned, and they roll it into another CD for another 12 or 18 months or what have you, and so they just like having it to where it's making that interest extra interest on it. That's more than you would make in a savings account, but at the same time they will have. They know okay, I'm gonna have access to that money in 12 months, I'm gonna have access to that money in 18 months. And then, if they get to where it's maturing and they don't need it, they go okay, well, it looks as though I'm not going to need that for another. You know 18 months. So they just roll it over and do another CD.
Speaker 3:Yeah, you just need to watch the interest rates that are available on CDs. You know, if you're doing that, a lot of times the institution will offer what we call an off-term CD, so something that's not like 3, 6, 9, 12, 18, 24 months. Maybe they're offering a 14-month CD and usually when they do that they have a special rate that they do it at. Maybe it's a bit higher for some reason, but a lot of times when those mature those automatically roll into whatever their 12-month CD rate is at the time. So if you did something on an off-term and you're trying to maximize your interest, you know it kind of pays to when those things mature to see if that was better. Moved to a different institution maybe, or even maybe a different interest maturity on the CD within that same institution.
Speaker 1:Right, and if things are such that CDs go, you know, maybe you have your money into whatever term CD and you have it at 5% and now the market shifts and when your cd matures, now cd rates drop to one percent and you then you could go ahead and take that money. You can go okay, I'm gonna take that and invest this over in this different vehicle because it's making five or six percent or something like that, and then maybe that's something that doesn't have a maturity date, such as maybe you put into some mutual funds that are a little bit safer, and if that's what you're seeking, and then if CD rates go to where they're higher, then you can move that money back over if you want to.
Speaker 3:Sure, and I think a big thing to think about is purchasing power. Purchasing power so if you put money into a CD at 5% for a year and the inflation average inflation rate during that time is 6%, you've lost. When you take your money out of the CD a year from the future, you actually have less purchasing power, earning the 5%, than what you did beforehand. That's true.
Speaker 1:I just think right now, I mean, I think inflation is really high and it's how do you do that? You're just kind of like well, you know, these are all the different things that are being offered as far as investment vehicles and inflation is just higher than what the different investment options are, except for stocks, of course. But then it's if you're risk adverse and you're like I don't want to take a chance with that, then you almost have to decide. You know, am I just going to earn less than what inflation is currently, or am I going to take a risk in the stock market? Or you know, what they like to say is diversify, so you could split it up into different things, so you're not losing. If something does go south on your investment, you're not losing everything, you're just losing a portion of it.
Speaker 3:So being risk averse, and this is an interesting story. In the 1990s the stock market in Japan was really really flat, didn't change hardly at all, and a lot of rich Japanese were real concerned with the market and interest rates were extremely low. So they would have a situation where, you know, they did an interview with an investor that had a million yen and he invested it in an overnight money market account that earned about the same amount he would earn as if he went and worked at McDonald's for the day. And when they ask him, why did you do that? Basically it's because I'm scared of the risk and the rate of return in the stock market is not high enough comparable to the risk of putting it in there. So that's all they did.
Speaker 1:Wow. When you don't really know what's going on and you're risk adverse, sometimes you know the safer choice is the best choice. It just depends on where you're at with all that and what you want to do.
Speaker 3:That's true, and what I can say is the only way you will know what is the right choice is after the choice has been made and looking back at hindsight.
Speaker 1:That's with everything right. You know it's. I call it 2015 vision, a lot of people call it 2020, but I'm like no, you, you can really zero in on what you did wrong or what you didn't like, or how your choice was good or was bad. Or you know, maybe it was mediocre and you know some parts of your choice was good and some parts were bad, and so you can really, you know, zero in on that in hindsight, on every decision in life that you do I will say that my choice in asking you to marry me is brilliant.
Speaker 1:I would agree with that. I agree that choosing to marry you was one of the best choices I've made, but overeating pizza at this new pizza place we found has not been the best choice lately. It's really good pizza, but too much of a good thing just isn't.
Speaker 3:Yeah, I was thinking about that when we're talking about bad choices.
Speaker 1:you know just isn't?
Speaker 3:yeah, I was thinking about that when we're talking about bad choices.
Speaker 1:You know I was comfortable last night having one piece of their cheese bread and two slices of pizza, leaving it at that yeah, I think I can only handle about one, one slice when we're when you're talking about life choices and looking back in hindsight, it's not just investments, it's, it's everything.
Speaker 1:You know, everything that we do.
Speaker 1:And I think one thing though when you do make an investment decision, once you make it and if it doesn't turn out the way that you thought, just it's kind of like that thing of when you fall down and you scrape your knee just get back up, brush yourself off and go on down the road and say, okay, that's information that I have, that's experience that I have, and now I've learned from that. And I can go on down the road and say, okay, that's information that I have, that's experience that I have, and now I've learned from that. And I can go on down the road and, you know, apply that knowledge to future choices. So I think sometimes people make choices, you know and I'm just going to relate it to finances or investments, because that's what we're talking about but a lot of times we make choices and we really get down on ourselves when it wasn't the best choice. And I just say you know what, learn from it and take that, as you know, an experience you can put in your back pocket and move on down the road.
Speaker 3:The key is to learn from it. Learn from it.
Speaker 3:You know because we do that. You know, in lending we always used to have the thing called the spilled milk report. So if a loan went bad, you'd have to do some analysis of, okay, who spilled the milk and when was it spilled. It's the same thing with investments. So if you invested in a stock and it went really really bad, then, okay, what were signs in the stock that at the time I was investing in it that I should have picked up on? Or is there other news that came out, or something like that? Afterwards, did I hold it too long, and learning some of those things will help you be maybe a little wiser the next time around.
Speaker 1:Sure. Well, I think that's all that we have for today on whether you should buy a CD or invest your money in a CD or invest your money in a 401k.
Speaker 3:And the answer is yes.
Speaker 1:The answer is yes. It depends on what your goals are, and maybe you're. You definitely want to invest in a 401k. If you have an employer match, so definitely do that so you can take full advantage of that extra money that would be going into your 401k, of that extra money that would be going into your 401k. And look at doing a CD if you can. If you have money in your savings and you don't need it for the next however many months and you can earn some good interest on that and you don't want to tie it up in anything else, then that might be a good choice too.
Speaker 1:I recommend laddering those. You know. Staggering or laddering is the the word that's typically used, but you know doing a little bit in one and little you know, maybe in a 12 month or six month or nine month, and then doing one that's, you know, a little bit longer, and so that way you have them maturing at various dates. So there's the answer to that and hopefully that helps out, Tim and we appreciate the question, and that's all I have for today, and I just want to say thank you for listening to the Life, Love and Money podcast. I'm Dr Angela K Love.
Speaker 3:And I'm Phil Love and make sure that you like us. And also any questions you have, feel free to write in, because we'd love to have more questions for the next show. Yep, absolutely, we want to hear from you. We'd love feedback. Have more questions for the next show?
Speaker 1:Yep, absolutely. We want to hear from you, we'd love feedback, and so you can do that one of two ways you can go on to my website of AngelaKLovecom and you can use the contact form. My email address is Angela at AngelaKLovecom and that's Angela at AngelaKLovecom, and you can email me there and send in any questions you have, and I do answer those personally. And if you're not on our newsletter email list, you can sign up for that on my website at Angela k lovecom and you will get a weekly email from me on Fridays and I do not sell or give away my list, so you don't have to worry about that and I don't spam so because I don't like that and I don't want to do it to other people. So that's all we have for you today. Thank you for listening and we will be back next week.