By Wendy Mihm | June 9, 2011
What is CD laddering and how can it help you earn some cash?
As you know, CDs are generally considered a safe place to stash your cash, but they have been pretty frustrating in the past decade, as interest rates have hovered frustratingly close to the zip, zero, bagel mark.
Add to that, the fact that CDs typically require one to lock up funds for 1-5 years for the chance at earning a decent rate of return, and you’ve got a recipe for some pent-up frustration among would-be investors.
But two things about CDs could help ease this frustration and put a little oomph behind this investment vehicle.
Thing 1: Interest rates are likely about to go back up again in the near future, making rates on CDs more attractive. To gain some basic understanding of why, read my guest post on our partner, AboutOne’s blog, called The State of the Rates.
Thing 2: CD laddering can allow you to access some of your funds sooner, while still investing the rest of them in higher-yeild, longer-term CDs.
How CD laddering works
Here’s a super-simple example of how to ladder CDs, using a $5,000 investment. You would divide up your money into 5 equal increments of $1,000, and then invest each $1,000 into 5 different CDs, with the following interest rates and maturity rates (rates are based on what I researched online on 6/8/11):
- $1,000 at 1.2% to mature in 1 year
- $1,000 at 1.48% to mature in 2 years
- $1,000 at 1.75% to mature in 3 years
- $1,000 at 2.0 % to mature in 4 years
- $1,000 at 2.45% to mature in 5 years
As you can see, you would have access to some principal and some interest of your initial $5,000 every year. At those times, you could decide what to do with the money – either re-invest it in another CD, re-invest it in a more aggressive investment, or spend it on something you need at that time.
The key things to remember about CDs in general are:
- Interest is paid upon maturity of the CD, not along the way, like a savings account.
- Their earnings are subject to taxation.
- If you take your money out of the account before the CD’s maturity date, you will pay a fee that may cut into your principle dollar amount.
- CDs are considered to be extremely safe because they are insured by the FDIC in the same way that traditional savings accounts are – that’s why the rates are generally so low – you’re not getting much because you’re not exposed to much risk.
The benefits of a CD laddering strategy
CD ladders are more flexible than tying up all your money into one long-term CD. You might not earn quite as large a return (the returns aren’t large anyway), but you’ll have access to your cash along the way.
On the other hand, if rates increase as time goes buy, you’ll have the flexibility to move your money into where it can earn a better return.
CD laddering just might be a flexible and safe way to earn better returns on your family’s investments – especially now, as interest rates are likely about to rise.
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