Using CD Ladders To Save Wisely

While I’m on vacation, I’m having other writers fill in and write guest posts. This is a guest post from Matthew over at CDLadders.com. CD Ladders is a great resource for learning about how CD ladders work, where you can set them up, and the benefits of using a CD ladder. If you enjoy what you’ve read, please be sure to visit Matthew’s site and check out the other great posts.

Although bailing out of the stock market may not be a good idea, unsteady economic times like today’s tend to make you look around for safer places to keep at least some of your money.  Certificates of deposit (CDs) can be an intriguing option due to their virtually risk-free nature and reasonable returns.

Characteristics of CDs

Like traditional savings accounts, CDs are federally insured by either the FDIC or NCUA.  This means you could deposit up to $250,000 at a particular bank or credit union without worry.  The only way you’re going to lose money with a CD is if the inflation rate exceeds your interest rate.  Fortunately, CDs tend to offer higher rates than a traditional savings account.  Currently, the APY for CDs at online institutions varies between 3.50% and 4.50%.  This type of return isn’t going to make you rich in a hurry, but it’s not terrible either.  Many people have trouble realizing more than that with any type of investment.

The downside with CDs is that when you do find a particularly lucrative investment, your cash is locked up.  CDs are time deposits, and the term can be up to several years long.  If you wish to withdrawal you money, you will face significant fees.  Yet, there is a way to enjoy the interest from long-term CDs while remaining more liquid.

Enter the CD Ladder

Typically, the longer the term is for a CD, the higher the interest rate.  A 6 month CD may offer 3.50% while a 36 month CD offers 4.50%.  No one, of course, wants all of their money to be locked up for three years.  You might face an emergency or find a better investment that requires some of you cash.  To help solve this problem, a CD ladder can be used.  A CD ladder is simply a series of CDs with staggered maturation dates.

To start a CD ladder, you might divide your total deposit into 6 equal parts and open 6 different CDs.  These CDs would have terms of 6, 12, 18, 24, 30, and 36 months.  This way, some of your money becomes freely available for use more frequently.  The longest period you will ever have to wait to extract some cash is 6 months instead of 36 months.  However, you’re probably thinking that this situation doesn’t actually lead to the optimal interest rate because only a portion of your money is in the longest-term CD.  And you’d be right.  But here lies the trick: when each CD matures, if you don’t have a more pressing use for the money, you would re-deposit all of that money into a new 36 month CD.  Because your initial 36 month CD has already aged 6 months, this new CD will continue your “ladder”.  Eventually, all of your money will end up in the highest-yielding accounts, but in multiple, staggered, CDs.  If you use this technique to save and you continue to generate income, you’ll become wealthy before you know it.

Author: Jeremy Vohwinkle

My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.