Climb Your Way to Higher Rates
Discover the benefits of CD laddering
Interest rates are either at or hovering around historic lows. That sure is good news for borrowers, but if you’re looking to build your savings it’s not so good, especially if you’re a conservative saver interested in preserving your principal. In higher-rate environments, certificates of deposit, or CDs, have proven to be a smart way to earn a higher yield with your money while having the assurance of FDIC insurance. But with rates so low, investing in longer-term CDs means locking in today’s historic low rates.
There is, however, a way you can still get the benefits of CDs while potentially enjoying higher returns. It’s called CD laddering. A CD ladder is an investment strategy whereby you buy several CDs that mature over several years, thereby providing you with access to your money and protecting you against interest rate risk.
Bankrate.com provides an example of CD laddering, using the image of rungs on a ladder. “The first rung of the ladder is the shortest period. If you have $100,000 to invest over a five-year period, you’d invest $20,000 into a one-year CD on the first rung. The second rung would be a two-year CD at another $20,000 and the third a three-year CD at $20,000. This continues up to five years. As each CD matures, the next moves up a year, allowing you to reinvest that money each year or use it for other expenses. Since CD rates are low, CD laddering gives you the opportunity to reinvest each year if yields rise.”
Why CD laddering?
There are some great benefits to using this investment strategy, including:
- Liquidity. You will have a portion of your money maturing at various times, giving you the opportunity to access funds.
- Rate protection. You’ll reduce the risk of putting all your money on one CD in a low-rate environment. For example, in the example above, you could have put $100,000 in a five-year CD, but you would be buying that CD at a time when rates are at historic lows. If you choose to ladder the CDs, as noted above, you may be able to take advantage of higher rates along the way.
- Higher rates. CDs typically offer higher rates than money market accounts.
- Protection. Savers don’t have to sacrifice the security of their savings to get potentially higher rates.
How to ladder CDs
Now that you know the benefits of CD laddering, how do you set up a portfolio that works for you? There are a few ways. FoxBusiness.com offers these alternatives:
- The straight ladder. With this strategy, “you set up your CDs to mature at staggered times like every six months, year or two years. This way you are in a good position to take advantage of higher interest rates as your CDs mature, and you should earn more money than you would if you kept all your money in short term CDs or savings accounts.”
- The barbell CD ladder. “With this strategy you invest half of your money in long-term CDs. The other half is kept in short-term CDs, say CDs with terms of one year or under. This approach gives you protection against the risk of rates staying low or suddenly moving higher. Your long-term CDs with higher rates will help you if interest rates stay low. Your short-term CDs stand ready to take advantage of … rate specials as they mature.”
- Hybrid barbell ladder. With this strategy, “you place half your funds in long-term CDs and the other half in … money market accounts to wait out better rates. The hybrid ladder is attractive if the best money market rates are as good as short-term CD rates.”
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