Wednesday, March 30, 2011

CD Laddering

I wrote a post about certificate of deposit (CD) a few days ago and mentioned a strategy called “laddering.” It’s a common and effective strategy for maximizing your savings. Basically, it's splitting your money into a few groups and opening CDs with different term intervals.

Laddering is useful in two ways. For one, it's a good method to maximize interest. It also makes your assets more liquid because you have the maturity dates of the CDs staggered. The longest term CDs tend to have the best rates, but that also means your money is locked in for the longest. A 5 year CD, for example, may pay 3% in interest as oppose to 1.05% for an 18 month CD. However, interest rates could go up during that 60 month time period. By spreading your assets, you give yourself more flexibility.

For a beginner, it's sufficient to just split up the total amount equally between a few different lengths of maturity. For example, if you have $10,000 to save, you can put $2,500 into a 24 month, 36 month, 48 month, and 60 month CD. This way, you'll be able readjust rates or withdraw a quarter of your money at each maturity date. Of course, you should research the difference in interest rates at multiple financial institutions before deciding on which CDs to deposit.

More advanced investors should take some other factors besides time distribution into consideration. It's always a plus to understand market trends. If rates are at an all-time low (like right now), they’ll either remain stagnant or move up. So maybe it's a good idea to open shorter term CDs (12, 18, 24, and 36 month) and skip the 4 and 5 year ones. By the time your CDs mature, chances of you being able to adjust to higher rates are high. Additionally, if the difference in rates is minimal between an 18 month and a 24 month CD, consider putting your money in the 18 month CD (assuming rates are going up). If you think rates will get lower, then keeping the money in there longer would be okay.

Don't forget to record the maturity dates so you're prepared to make the necessary decisions when your certificates' terms are up. As always, check that the financial institutions you choose are insured by either the FDIC or the NCUA.


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