ECON 111c, Project 1 – Investment Assets Chart
Source: Investment Assets Chart handout
Tags: IRA, individual retirement account, 401(k), certificate of deposit, CD, retirement planning, tax-deferred, tax-free growth, savings instruments, ECON 111c, intro microeconomics, University of Texas at Austin
Difficulty: Introductory
Prerequisites: Familiarity with the basic investment asset types (stocks, bonds, funds) covered in Part 1 of these notes.
Retirement accounts and savings instruments are the long-game side of personal finance. Where stocks and bonds are the building blocks, retirement accounts like IRAs and 401(k)s are the wrappers that hold those building blocks and give you tax advantages for doing so. Certificates of deposit sit at the other end of the spectrum: extremely safe, extremely predictable, and useful when you need to lock in a return without any risk. This material completes the investment-assets picture started in Part 1 and prepares you for portfolio-allocation questions.
IRAs and 401(k)s are tax-advantaged accounts designed for retirement savings. They hold other investments (stocks, bonds, funds) inside a structure that defers or eliminates taxes on growth. Certificates of deposit are fixed-term bank products that guarantee your principal and a set interest rate. The trade-offs are access (retirement accounts penalise early withdrawals; CDs lock your money for a set period) versus tax and safety benefits.
IRA (Individual Retirement Account)
A government-sponsored, tax-deferred personal retirement plan. Contributions may be tax-deductible (traditional IRA) or made with after-tax money that then grows tax-free (Roth IRA).
Think of it as: a personal savings account with special tax rules that reward you for leaving the money alone until retirement.
401(k)
A qualified employer-sponsored retirement plan that allows employees to save and invest a portion of their salary on a tax-deferred basis. Employers often match a percentage of contributions.
In simple terms, this means money comes out of your pay before taxes, grows without being taxed each year, and you pay taxes only when you withdraw it in retirement.
Certificate of Deposit (CD)
A time deposit issued by a bank where you agree to leave your money for a fixed period (e.g. 6 months, 1 year, 5 years) in exchange for a guaranteed interest rate.
Think of it as: a deal with your bank where you promise not to touch your money for a set time, and in return they pay you a higher rate than a regular savings account. Your principal is safe, but your money is locked up.
Government-sponsored retirement savings vehicle available to individuals.
Contributions to a traditional IRA may be tax-deductible. The money inside grows tax-deferred, meaning you pay no taxes on gains until you withdraw.
With a Roth IRA, contributions are made with after-tax income, but withdrawals in retirement are entirely tax-free.
The main disadvantage is a relatively low annual contribution limit. For the purposes of this course, know that the cap exists and constrains how much you can shelter from taxes each year.
Early withdrawals (before age 59½) typically incur a penalty, which is the trade-off for the tax advantages.
Employer-sponsored retirement plan. Contributions come directly from your salary before income tax is calculated.
Tax-deferred growth: your investments compound without annual tax drag, which accelerates long-term wealth building.
Many employers offer a matching contribution (e.g. they match 50% of what you contribute up to a certain percentage of your salary). This is essentially free money.
The main disadvantage is longer waiting periods. Your money is locked up until retirement age, and early withdrawals face penalties and taxes.
401(k) plans typically offer a menu of mutual funds to invest in, tying this concept directly to the funds material in Part 1.
Issued by banks. You deposit a fixed sum for a fixed term, and the bank guarantees your principal plus a set interest rate.
Security is the headline advantage: your deposit is FDIC-insured (up to the insurance limit), so you will not lose your principal.
The trade-off is liquidity. If you need your money before the CD matures, you will typically pay an early-withdrawal penalty.
CDs generally offer higher interest rates than regular savings accounts, but lower returns than stocks or bonds over the long run.
Useful for money you know you will not need for a specific period and want to keep entirely safe.
The project asked you to allocate $50,000 across these asset types. One example allocation from the source material:
Preferred Stock: $10,000 (steady dividends, moderate risk)
Mutual Funds: $10,000 (diversification, professional management)
Corporate Bonds: $5,000 (interest income, some convertibility)
IRA: $10,000 (tax-free growth for retirement)
401(k): $15,000 (tax-deferred growth, largest single allocation)
This totals $50,000. The reasoning behind this mix balances growth (mutual funds, preferred stock), income (corporate bonds), and long-term tax-advantaged savings (IRA, 401(k)). There is no single correct answer; the point is to justify your choices using the advantages and disadvantages of each asset.
Students often think an IRA and a 401(k) are specific investments. They are not. They are account types (wrappers) that hold investments like stocks, bonds, and mutual funds. The tax benefit comes from the account structure, not from what is inside it.
Students sometimes assume a CD is the same as a savings account. A CD locks your money for a fixed term at a fixed rate; a savings account lets you withdraw at any time but pays a lower rate.
A common error is believing that "tax-deferred" means "tax-free." With a traditional IRA or 401(k), you still pay taxes, just later, when you withdraw the money in retirement. Only a Roth IRA offers truly tax-free withdrawals (on qualified distributions).
Students occasionally confuse the 401(k) employer match with a loan. The match is a contribution from your employer to your retirement account. You do not repay it.
If your employer offers a 401(k) with a match, contributing at least enough to capture the full match is widely considered the single best financial move a young worker can make. IRAs are how self-employed people and freelancers access similar tax advantages. CDs are commonly used by retirees or savers who want a guaranteed return on money they will need at a known future date (e.g. a tuition payment in two years).
⚠️ Know the difference between tax-deferred (traditional IRA, 401(k)) and tax-free (Roth IRA). This distinction is frequently tested.
⚠️ Be able to name the main advantage and main disadvantage of each: IRA (tax-free growth / low contribution limit), 401(k) (tax-deferred + employer match / early-withdrawal penalty), CD (guaranteed principal / locked-up money).
⚠️ Understand that IRAs and 401(k)s are account types, not investments themselves. The investments inside them can be stocks, bonds, or funds.
⚠️ If asked to justify a portfolio allocation, always tie each choice to the advantages and disadvantages listed in the chart. Show you understand the trade-offs.
True or false: A 401(k) is a specific type of investment, like a stock or bond.
Answer: False. A 401(k) is a retirement account that holds investments such as stocks, bonds, and mutual funds.
Fill in the blank: The main advantage of a certificate of deposit is ______.
Answer: Security (guaranteed principal and a fixed interest rate, with FDIC insurance).
True or false: With a traditional IRA, you never pay taxes on your investment gains.
Answer: False. You pay taxes when you withdraw the money in retirement. The growth is tax-deferred, not tax-free.
Q: What is the key difference between a traditional IRA and a Roth IRA?
A: With a traditional IRA, contributions may be tax-deductible and you pay taxes on withdrawals in retirement. With a Roth IRA, contributions are made with after-tax money, but qualified withdrawals in retirement are tax-free.
Q: Why might someone allocate a large portion of their investment to a 401(k)?
A: Tax-deferred growth means investments compound faster because you are not losing a portion to taxes each year. If the employer also offers a match, that is an immediate return on the contribution. For long-term retirement savings, these advantages are substantial.
Q: An investor has $10,000 they will need in exactly two years for a down payment on a house. Which asset from this unit is the best fit, and why?
A: A certificate of deposit with a two-year term. The principal is guaranteed (FDIC-insured), the interest rate is fixed, and the timeline matches. Stocks or bonds could lose value over that period, and retirement accounts penalise early withdrawals.
Q: Why is a CD generally considered safer than a corporate bond?
A: A CD is issued by a bank and insured by the FDIC up to the coverage limit, so you cannot lose your principal. A corporate bond depends on the issuing company's ability to repay; if the company defaults, you may lose part or all of your investment.
Retirement accounts hold the same instruments covered in Part 1 (stocks, bonds, mutual funds), so these topics are directly linked. The concept of opportunity cost applies to every allocation decision: money in a CD cannot also be in a mutual fund earning a potentially higher return. Tax policy, which you will encounter later in the course, directly shapes the attractiveness of IRAs, 401(k)s, and municipal bonds.
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