What is a CD Ladder and should you have one?
The strategy is called a CD ladder, and we're going to explain what it is and help you decide if you should set one up for yourself.
First of all...What is a CD?
In order to talk about CD ladders, we first have to understand exactly what a CD is. CD is short for Certificate of Deposit. It's basically a savings account...but not exactly. When you put money into a savings account, you don't do it solely for the purpose of getting a return on that money. But a CD? CDs are all about the return.
Once upon a time, you could get a several percent return on some CD accounts. (we remember getting almost 10% at one point!) While rates aren’t quite what they used to be - CD's still offer higher rates of return than traditional savings accounts. CDs are insured by the federal government too, so you can rest easy knowing your money is protected.
The interest rate for a typical savings account is usually around .02% APY (that stands for annual percentage yield if you are, you know, not a huge finance nerd like us). So let’s say you put $100 into a savings account and leave it for one year, you’d make 2 cents on your money over the course of the year. A CD in 2021, on the other hand, can be between .10% APY and .65% APY depending on the length of the term. The longer the term of the CD, the higher the interest rate.
So what’s the downside? CDs have a fixed maturity date. This means that your funds are locked into a CD for a set amount of time, and withdrawing the money prior to the maturity date will result in a penalty. And no one likes penalty fees.
Didn't you say something about a CD ladder?
Committing to lock your money away for up to 5 years can be a difficult pill to swallow. What if something comes up and you suddenly need your money? By laddering your CDs, it can make that commitment a lot less daunting.
In essence, a typical CD ladder is a 5 year savings strategy with an option to cash out each year.
Say you had $12,500 you wanted to put into a CD account. Instead of putting the full $12,500 into a single CD with a high interest rate and a 5 year term, you split your money up 5 ways and place them into CDs like this...
- $2,500 into a 1 year CD at .15% APY
- $2,500 into a 2 year CD at .25% APY
- $2,500 into a 3 year CD at .35% APY
- $2,500 into a 4 year CD at .50% APY
- $2,500 into a 5 year CD at .60% APY
As a CD matures each year, you reinvest the original $2,500 + the interest you acquired into another 5 year CD with the highest possible interest rate, which will look like this. (As the CDs mature each year, you always have the option to cash out instead of reinvesting.)
- After 1 year: $2,500 + 1 year of interest ($3.75) reinvested into a 5 year CD at the highest rate available
- After 2 years: $2,500 + 2 years of interest ($12.52) reinvested into a 5 year CD at the highest rate available
- After 3 years: $2,500 + 3 years of interest ($26.34) reinvested into a 5 year CD at the highest rate available
- After 4 years: $2,500 + 4 years of interest ($50.38) reinvested into a 5 year CD at the highest rate available
- After 5 years: $2,500 + 5 years of interest ($60.54) reinvested into a 5 year CD at the highest rate available
After those first 5 years, assuming you didn’t take anything out of your CD ladder, you'll have 5 year term CDs maturing every year - getting the highest possible rate and making the most on your initial $2,500.
So, should you set up a CD ladder?
If you have money sitting in a savings account that you’d like to keep saved (and working for you!) over the next few years, a CD ladder is an easy yes. After all, who doesn’t like making money while they sleep?
While CD ladders may take a bit more energy to set up, they’ll definitely be worth it in the long run and can beat your average savings account any day.
If a CD ladder sounds like something you’d like to set up for yourself, give your local banker at Starion a call or stop in and set your CD ladder up today.