Climb Your Way to Better Returns by Organizing a Flexible CD Ladder

Jacob Harper

By Jacob Harper
Posted on Thu Aug 7, 2014, Last Updated on Thu Aug 7, 2014

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Certificates of deposit, or CDs, are about as safe as an investment can get. You put money in, later on you take it out with added interest on top. No sweat.

Even though CDs are easy to buy, that doesn’t mean getting the most mileage out of a CD investing strategy is. To get the most out of them you have to pick and choose wisely.

Climb Your Way to Better Returns by Organizing a Flexible CD Ladder

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When shopping around for a CD, it might look like the obvious choice is to pick just the ones that pay the most money. After all, the point of investing is to get the most bang for your buck, is it not?

Not when you look at the reality of CDs. While CDs pay out a higher percentage than say, a savings account, CDs aren’t liquid. That is, once you invest in a CD, that money is locked up and can’t be withdrawn without incurring a penalty, usually somewhere in the neighborhood of three to six month’s worth of interest. But in some cases, the penalty can actually be severe enough that it eats into the principal, meaning you lost money on what is otherwise an essentially riskless investment.

Highest yield CD every time?

The other obvious downside for going for a just-the-highest-interest-NOW approach is that you’re probably going for the CDs with the longest maturation dates. That means you’re locking your money away for a long time. Sometimes five years, sometimes even longer.

A lot can happen in that time. Cogent to a discussion on CDs, a lot can happen to interest rates. That is, they can go up. In that case, you’re stuck with a CD that’s paying below market value. And if inflation cranks up high enough, you could actually end up losing money. Of course, the reverse is also true, wherein you can lock in a favorable interest rate. This is what happened with people who bought multi-year CDs right before the Great Recession, when CD buyers who locked in pre-2008 came out much better than their stock-investing counterparts.

This is not to say that there is zero reason to ever get a long-term CD. Like most money strategies the key is to diversify and stagger your savings so they cash out at regular intervals. This is sometimes referred to as a CD ladder.

While there’s nothing set in stone, an easy, fairly conservative CD ladder calls for just buying a wide mix of CDs all at once. That is, a mix of CDs that will mature at evenly spaced intervals, like every six months over a period of five years. To get an idea of the latest CD rates, see the table below.


What this does is spread your returns out, so you’ll have access to your savings at regular intervals throughout the years. It’s simple and doesn’t take any work after the initial investment. However, it does ignore the realities of the market, one in which interest rates change constantly, by putting you all in at the same time.

The flexible CD ladder

Another deviation from this most conservative of CD ladders does impart the slightest bit of risk, but it also allows a CD buyer the chance of being able to take advantage of higher interest rates down the road.

Here’s an illustration: in response to the economic fallout, over the last few years interest rates have been kept at historic lows. In turn, in 2013 six-month CDs were paying out the lowest returns since negotiable CDs were first introduced in 1961. So for an investor in 2013 who went all-in on their CDs definitely came out on the short end, historically speaking.

Does this mean CD rates should continue falling? Or will they rebound? That’s a nay impossible question to answer decisively, but it does go to show that locking up the highest rate just by buying the highest-yielding CDs at the time of purchase can be a little short-sighted.

This is why it’s often a good idea to set aside some money in a place where it’s easily accessible like a savings account, so if and when rates do fully rebound off of the historic 2012-2013 lows the savvy depositor can latch onto a favorable rate.

Of course, a higher interest rate could always be around the corner. If that was the case, everyone who invests in CDs or Treasury bills or any other comparable low-risk investment would just wait forever and ever. That’s where the flexibility of a CD ladder comes into play.

Being willing to adjust your ladder accordingly in response to the times is crucial. When assembling the ladder one doesn’t want to drastically change their style of investing, but it helps to be able to have the available funds to grab a CD when the rates are favorable.

Above all, the name of the game is diversity. That’s what makes a good CD ladder. A variety of rates, all guaranteed to increase in value, staggered in maturation rates, leaving the cash to jump on good opportunities should they arise. With a diversified CD ladder, a person can save their money, have access to funds, and put a dent in inflation-related value loss without risking any kind of loss at all.

 

Post a Comment

  • Joseph Briggs

    CD Ladders are great. You get the best of both short and long term CDs. I have a CD with Ally Bank. For anybody reading this article and considering this should check them out.

    • Jacob Harper

      Those internet banks like Ally certainly do pay out pretty well on their CDs.

  • Peter Bennett

    Right now, i’m staggered by the paltry savings rates offered to savers. Wish we would return to the days when banks paid a fair amount of interest. Maybe those days will soon return. A little rate inflation does a savings account good!