This article was updated on May 7, 2016.
Many people fundamentally misunderstand IRAs, thinking they're just another type of bank account like a CD that pays a fixed interest rate over a period of time. Yet even though you can open a retirement account that invests in interest-bearing accounts, the best IRA interest rates right now don't stand a chance of matching the long-term results of more aggressive investment strategies that go beyond FDIC-insured bank accounts.
Unleashing the full power of your IRA
If you look for the best IRA interest rates, you'll find a host of different banks offering various types of products, including savings accounts and certificates of deposit. But because the Federal Reserve has held short-term interest rates low for years, you'll find that most institutions pay extremely low rates on IRAs. For instance, a check for the top rates in the country right now showed the best you can do on a one-year IRA CD is about 1.35%. That's not even enough to keep pace with the loss of purchasing power from inflation, let alone provide any real return. Even if you're willing to lock up your money until 2021, you'll add less than a percentage point to your IRA interest rate, with one of the top providers paying 2.10% for a five-year IRA CD. That's barely more than the current inflation rate and below the historical average for inflation over the long run.
But if you're looking for the best IRA interest rates you can find, you might not even realize that you don't have to go to a bank to open an IRA. The best thing about IRAs is that they're extremely flexible ways to invest for retirement, allowing you to buy anything from individual stocks and bonds to mutual funds and exchange-traded funds that offer diversified portfolios of multiple investments in a single, easy-to-buy package. And if it's income you want, there are ways to get it that can actually pay you more than you'll get from the best IRA interest rates on CDs and other bank accounts right now.
Looking at conservative dividend stocks
Millions of investors have discovered the power of dividend stocks that both pay current income and provide growth potential. Unlike an IRA CD, holding individual dividend stocks in your IRA gives you the chance to see your invested principal grow in value, rather than simply relying on interest payments for minimal returns.
Obviously, investing in stocks also involves greater risk. Unlike an IRA CD, you can lose money that you invest in stocks within an IRA. As a result, most people won't want to invest all of their retirement savings in stocks.
But even if you limit yourself to some of the largest corporations in the world, you can find dividend yields that pay double what you'll get from the best IRA interest rates out there. Consider the following:
- Verizon (NYSE:VZ) is the largest wireless carrier in the U.S., and it pays a dividend yield of 4.5%. It faces plenty of competition in the wireless network arena, but it also has plenty of expansion potential as it fights to grow its market share and build out what many believe is the highest-quality network in the nation.
- Philip Morris International (NYSE:PM) is one of the companies behind Marlboro cigarettes. While it doesn't sell to U.S. customers, but rather around the world, Philip Morris has turned to new markets for tobacco as avenues for growth that domestic tobacco companies have largely left untapped. Philip Morris has a solid history of dividend growth and currently pays 4% in dividend yields.
- Total (NYSE:TOT) isn't a household name among American investors, but the French oil giant has extensive holdings around the world, including promising areas from the Bakken shale play of North Dakota and the extensive natural gas fields of Papua New Guinea. Oil's plunge in 2015 made many investors nervous about major oil and gas stocks, but Total's dividend yield of nearly 6% also gives shareholders exposure to the future prospects of solar power, with the company holding about two-thirds of the outstanding shares of U.S. solar giant SunPower (NASDAQ:SPWR). For those who fear an eventual shift away from fossil fuels, Total's holdings in SunPower show the company's forward-thinking nature.
All three of these companies have market capitalizations of more than $100 billion. That doesn't mean that they're immune to declines, but they're less likely to suffer a complete collapse than smaller, more speculative stocks that don't have the extended track histories that these companies possess.
It's tempting to try to lock in a sure thing by seeking the best IRA interest rates you can find. But given how low those rates are, your better bet is to put at least some of your money into income-paying stocks. Over the long haul, you'll find that the combination of income and growth will likely keep you ahead of the game.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Total. The Motley Fool owns shares of Philip Morris International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.