Boost Returns With a CD Ladder
Like savings and money market accounts, certificates of deposit (CDs) are relatively low-risk savings vehicles. But CDs offer higher interest rates because the balance cannot be withdrawn without incurring a penalty until the CDs mature. Using a strategy called “CD laddering,” you have regular access to funds and capitalize on better savings returns.
Banks may offer CDs with a wide range of maturity durations. However, the longer durations tend to offer the better CD rates — usually found with 5-year CDs. Not being able to touch your money for five years is a little daunting for many savers. This is where CD ladder proves useful.
Imagine CD laddering as a game of leapfrog (“CD leapfrogging” may have been a better name for this strategy).
Initially, you split up funds across CDs with durations that increase in fixed increments. Then, renew CDs for the longest duration.
For example, with $10,000, you can put $2,000 each into 1-, 2-, 3-, 4- and 5-year CDs. When each CD reaches maturity, you reinvest the funds into 5-year CDs. This approach means you can take advantage of higher CD rates without sacrificing access to cash (part of your funds becomes available on a yearly basis).
Set up CD Ladder
CD ladders can be customized for your individual financial habits and needs. You may prefer to set up a CD ladder so that funds become available semi-annually. Or, you can use shorter CD durations. Furthermore, don’t be afraid to cycle your funds into CDs at a different bank if the bank offers higher rates (though it will be more difficult to manage).
Other things to keep in mind are early-withdrawal penalties and CD-renewal terms.
In the event of an emergency, you can pull out the money from a CD but get hit with an early-withdrawal fee, which is usually equivalent to several months worth of interest earnings. Each CD may have its own early-withdrawal fee, so keep it in mind when choosing a CD.
Depending on the bank, renewal terms for CDs can vary — not understanding them may ruin your CD ladder. For example, you don’t want to automatically renew CDs that are less than 5 years. Or, you don’t want to renew a CD because you want to move that money to a CD at another bank that offers a higher rate.
Sure, the entire concept of CD laddering may involve a little more work but the financial incentive is enticing.
Simon Zhen is the senior research analyst for MyBankTracker. He is an expert on consumer banking products, bank innovations, and financial technology.
Simon has contributed and/or been quoted in major publications and outlets including Consumer Reports, American Banker, Yahoo Finance, U.S. News – World Report, The Huffington Post, Business Insider, Lifehacker, and AOL.com.