When it comes to saving, most of us are familiar with a traditional savings account, but what about CDs? Read on to learn more about what CDs are, how they work, and how CD laddering could be an option to help you save more.
What are CDs, and what can they be used for?
A CD, or certificate of deposit, is a savings product offered by financial institutions that earns a locked interest rate for a fixed period of time, determined at the time of purchase. Upon deposit, you agree to keep your money in the CD without taking a withdrawal for the duration of its term. In most cases, withdrawing money early means paying a penalty fee to the institution. At the maturity date, you can withdraw the funds, plus the interest earned, without penalty. The interest rate earned on CDs is typically higher than that of a savings or money market account.
What is CD laddering, and how does it work?
CD laddering is a strategy where you purchase more than one CD, each with different maturity dates. For example, you could build a CD ladder of 6 months at 1.00% APY, 12 months at 1.60% APY, and 24 months at 2.00% APY. (Rates subject to change and are listed here for illustrative purposes).
Why would someone be interested in CD laddering?
The benefit to laddering your CDs is you would redeem funds more often rather than putting all of your money in to one long-term CD. “Diversifying your overall portfolio, or ‘not putting all your eggs in one basket,’ is one of the keys to building wealth,” says Brian Kent, FAIRWINDS’ Vice President and Program Manager of Wealth Management.
What are the benefits of CD laddering?
There are several benefits to CD laddering strategies:
- Liquidity: You’ll have access to your money more often, without penalty, at which point you can choose to withdraw the funds or reinvest back into another CD.
- Interest rate risk mitigation: Interest rate risk is the risk of investing in a product with a fixed rate and if rates increase, you miss investing in benefits of the rising rates. According to Brian, “Your money would be ‘trapped’ in a lower rate. With laddering, you have regular access to money to reinvest in a potentially higher-rate product.”
- Long-term rate security: “On the flip side,” Brian adds, “a laddering strategy could also protect against rates dropping.” If you invest in both short- and long-term CDs, the short-term CDs will mature and be unable to capture the higher interest rates of the past, but the longer-term CDs will continue to be locked into the more attractive rates at the time of purchase.
- Insurance: CDs are deposit products and are federally insured by the NCUA up to $250,000, giving you peace of mind.
- Cannot lose value: CDs do not experience market volatility. You can calculate, at the time of purchase, the exact amount of interest that you will earn on the invested funds.
If you’re looking to build your wealth, CDs and CD laddering could be another effective option to help you save.