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Get a Leg up on Rates by Laddering CDs

By Peter McDougall- manybanking.com

 

In the wake of steep losses in the stock market, many investors are choosing to park their cash somewhere safe. The challenge, however, is finding a way to keep that cash accessible while still earning a decent return. One solution: certificates of deposit.

Category Product: 
CDs
Category Finance: 
Personal Finance
Introduction: 

By Peter McDougall- manybanking.com

 

In the wake of steep losses in the stock market, many investors are choosing to park their cash somewhere safe. The challenge, however, is finding a way to keep that cash accessible while still earning a decent return. One solution: certificates of deposit.

 

Certificates of deposit, or CDs, typically offer much higher interest rates than savings, checking or money market accounts. Rates for one-year CDs average 2.27% versus savings and money market accounts of 0.39% and 0.84%, respectively. The price of the higher interest rates: The promise to leave your money untouched for the duration of the CD, which can range from three months to five years. But there's a way to keep your cash accessible. It's called CD laddering.

 

A CD ladder is an investment strategy where the maturity dates of a number of different CDs are staggered over a set period of time. With this approach, you'll have access to a portion of your money at predetermined intervals. As one CD matures, you can either roll it over into a new CD at the going rate or invest it some other way.

 

Laddering gives you access to your cash while letting you take advantage of the higher rates available from longer-term CDs, which offer better rates. To understand how CD laddering can work for you, check out the online CD Ladder calculator at manybanking.com. To use the calculator, input how much money you want to invest, the amount of each CD and how frequently you want access to your money. You'll also need to enter in the rates for the various CD terms that you'll use in the ladder. To find local rates, check out sbup’s CD section and enter your ZIP code.

 

Example: Let's say you have $100,000 in cash and you want access to at least $20,000 of it every three months. To construct a CD ladder, you'll need to start off with a CD at each of three-month, six-month, nine-month, 12-month and 15-month maturities. In the New York metropolitan area, CDs with those maturities are currently around 1.9%, 2.5%, 3.0%, 3.3% and 3.9%, respectively. When that first three-month CD matures, take that money and roll it over into a new 15-month CD. When the six-month CD matures, do the same. By the time you roll over your initial 15-month CD, you'll hold five 15-month CDs set to mature at three-month intervals.

 

By setting up a ladder in this way, you'll earn $4,397.42 by the end of five years. By comparison, if all of your cash went into a single, three-month CD that you rolled over every three months, you'd only earn $2,380.61 after 15 months -- $2,016.81 less.

 

Setting up a ladder is a simple process. You need to figure out what intervals work for your financial situation and then buy the appropriate CDs from the institution with the most competitive rates. But it also takes time and effort to keep organized and make sure you roll over the cash into the next long-term CD as it matures. Otherwise the money won't be earning anything and you risk having your ladder fall apart. Another drawback is that you only have access to a portion of your money at any given time.

 

Meanwhile, be careful of locking up too much of your money in long-term CDs. If you put all $100,000 into a 15-month CD, for example, you run the risk of missing out on any rate increases in the future. Moreover, if you do end up needing that money for some reason, you'll face a stiff early-withdrawal penalty. That penalty can equal up to six months of interest or more, depending on the maturity of the term of the CD and your lender’s regulations. In some cases, it can leave you with less money than what you had when you started.

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