It was just a few years ago that my 12-year-old nephew asked his grandmother for a CD on his birthday. She was so proud that the young man was interested in looking for ways to build his finances that she wanted to open a new CD for him right away. I had to laugh just a little when I explained to her that he wasn't asking about an interest-bearing certificate of deposit from the bank, but rather a new compact disc just released by his favorite rock band! There's a lesson here somewhere, but that's for another post on another day.
Today we are talking about CD's (certificates of deposit), the kind that can help you round out your financial portfolio and help you reach your financial goals. The strategy is called laddering, and it helps you make some decisions about the terms and interest rates. Longer terms mean higher interest rates for CD's (in general) and shorter terms mean faster access to your money. A CD ladder strategy helps you balance higher rates with more frequent access to your funds.
Here's how laddering works. Rather than putting all your funds into one large CD for a single term, you spread the money out equally over several CD's for a variety of terms—let's say a 12-month, 24-month, and 36-month trio. Why do it that way? Think of each of these CD's as a rung on your financial ladder. Let me give it to you step by step:
Let's say you have $9,000 to open a new CD this year. Divide your deposit into several accounts, for example a 12, 24, and 36-month group (keep in mind this is just an example as you can divide your money into as many accounts as you like so long as you meet the minimum balance requirements, usually as low as $500).
When your original 12-month CD matures, convert it or “roll it over” to a new higher interest 36-month CD. When your 24-month CD matures, then convert that one into a new 36-month CD too. Maximize each CD as it matures into the longest term CD in your personal ladder to maximize your earnings.
At this point, the terms of all 3 of your CD's will now be 36 months. However, because of laddering, you will now have penalty-free access to a portion of your money every 12 months while still getting the higher interest rate of longer-term CD's! By setting up automatic renewals, you can keep this going on for as long as you'd like it to last.
You can open a CD ladder at your local bank, or better yet, I'd recommend opening them online at an online bank. These banks are offering rates that are far higher than your local brick-and-mortar banks. Recent rates I have checked for local bank CD's are about 0.01% for 12 months and under 1% for even 3-year terms. Online banks were offering 1.25% for 12-month accounts and as high as 1.75% for 3-year terms which is considerably better. Check gobankingrates.com for the best rates available in your area.
Keep in mind that you can ladder your accounts in various terms and amounts, so be creative and you'll see your returns grow faster with no risk at all. There is a tendency when rates are low to not want to lock in an interest rate for a long period of time. But no one knows how long rates will stay low, and in the meantime, you could be losing out on what interest is available.
CD's are a safe, insured investment in today's world. The interest rates available are not the best rates ever and interest is taxable (unless your CD's are inside a tax-deferred account), but CD's are FDIC insured and you will made gains that you cannot be guaranteed in other investments. It should be part of your total plan to build your savings, perhaps as part of your retirement plan or even your emergency savings by using a CD ladder built on monthly CD rungs. By laddering your CD's, your accounts can earn higher rate while having your money frequently accessible without risk, penalties, or early termination fees.
Are CD's part of your financial plan? Have you wondered if there's a way to make a little more interest and still have your funds available when you need them?