The Benefits of “CD Laddering”
The interest rates that banks pay on CDs are currently very low.This puts some consumers in a rather precarious position. If you don’t have enough money to take advantage of investments like stocks and mutual funds, or are perhaps too leery of non-FDIC insured accounts, CDs have traditionally been the way to go. But, with CD rates so low and banks paying CD interest rates based upon the amount deposited (the higher the deposit, the higher the rate, but even the highest The interest rates that banks pay on CDs are currently very low rates are not all that high), many people are asking “why bother” when it comes to investing in CDs. It is this situation that makes CD laddering an investment strategy to consider.
CD laddering is a method of benefiting from the changes in CD interest rates by opening several CDs at once, for different time commitments. This allows you to maintain a long term investment but still have some liquidity to the assets in the time deposit accounts. The ladder can be as long as you like, with as many investment rungs as you like (or can afford). For our example, we’ll use a five year ladder with $15,000 invested.
You have $15,000 to invest in CDs. You can put the entire amount in one 60-month CD and earn an interest rate of 3.69%* over the course of the entire five years. This ties up the entire amount for those five years, however, and should some need to withdraw part of those funds arise during the term, you could pay a hefty penalty fee to the bank. Also, if interest rates are higher a year from now, you’re still locked in to the same rate until the CD matures.
If, on the other hand, you open five separate CDs for $3000 each at terms of 12, 24, 36, 48, and 60 months, you’ll earn varying rates on the accounts (1.54% on the 12 month CD, 2.52% on the 24, 2.62% for 36, 3.01% on the 48, and 3.49% on the 60*), and commit smaller amounts of money for shorter periods of time. When the 12 month CD matures, you’re free to use the funds plus their accrued interest as you wish, or reinvest it in another 24 or 60 month CD. It’s a strategy that takes advantage of the benefits of a CD deposit while working around some of its drawbacks.
*Interest rates quoted were provided by Bank of America’s website as of 6/5/05. Rate structures may vary at other banking institutions or change at any given time.