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.

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Filed Under: Personal Finance

About the Author: Jeremy Vohwinkle is a Chartered Retirement Planning Counselor® and spent a few years working as a financial planner. Today, he helps people make the most of their money by writing about personal finance here and elsewhere on the web. Jeremy is also Coach at Adaptu and a regular contributor for other publications such as Intuit, and American Express. Be sure to follow Jeremy on Twitter or Google+.

7 comments
PennySeeds.com
PennySeeds.com

Yes, compounding interest is wonderful! I love it when my money earns me money. I hate paying financial institutions when they are already using my money.

They should be paying YOU for them to use your money. I love getting interest checks every month from the bank.

I'm not going to be using that money for a while, and so I don't really 'need' a ladder. The term will be up before I put it to use.

Jim
Jim

You only did the math for 1 year, not taking into account the power of compound interest.

You make a fine point, and I won't disagree with you, but I think CDs come down to risk management... immunizing a portfolio against future liabilities.

My Journey
My Journey

I don't get it! If you do the math you are locking up your money for a couple hundred bucks more a year? If you check out the link I did the math there.

Jim
Jim

Congratulations on being mentioned in Barrons this week. A couple addition points would be 1) you can structure the ladder to free up money for future foreseen liabilities such as purchasing a car or a down payment on a new home and 2) in using a strategy such as this you will always want to balance reinvestment risk (the likelihood early maturities will need to be reinvested at a lower rate) against the risk that inflation could erode the payment on longer term securities.

stocks
stocks

I think it's a great idea, plus it keeps the money out of my wife's hands so she doesn't spend it.
One year, a $1000 CD that we bought, helped pay for x-mas and bills when we remembered we had it.

Nick
Nick

CDs are becoming better and better options as of late, because those high yield savings accounts (ING, HSBC, etc.) rates have taken a real dive. If you can deal with having your money locked up, they're worth it.

Jacqui
Jacqui

I want to point out that it's not always the longest term CD that has the highest rates, and not all banks work on 6-month increments. I've got accounts with Century Bank Direct (highly recommend them! www.centurybankdirect.com), and here are their current CD rates:
5 Month CD: 4.01% APY
10 Month CD: 4.45% APY <-- highest rate is <1 yr !!!
15 Month CD: 4.16% APY
20 Month CD: 4.21% APY

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