Have you seen that interest rates are rising on some certificates of deposit, only to worry that you’ll miss out on further increases? You may want to consider putting your cash in several CDs with different terms — what’s known as building a CD ladder.
“It’s time to take CD ladders out of the attic,” said Chris Horymski, senior research analyst at the financial site MagnifyMoney.
CD ladders are a way to hedge your bet on interest rates. Longer-term CDs typically pay higher interest than short-term certificates. So, for example, if you had $50,000, you could buy five $10,000 CDs, with terms of one, two, three, four and five years. When the one-year certificate matures, you could reinvest that cash in another five-year CD — hopefully, at a higher rate — or use the money for something else. Meanwhile, the other certificates would be earning higher, longer-term rates.
Why would someone want to do this?
Rates on CDs as well as on basic savings accounts were so low for years after the economic downturn that it often wasn’t worth moving cash around. As the Federal Reserve has gradually raised its benchmark rate over the past few years, however, yields on savings have been inching up.
No one is getting wildly rich. But it’s now easy to find CDs at online banks insured by the Federal Deposit Insurance Corporation that pay well above 2 percent for a one-year term, and 3 percent or more on terms of five years.
The central bank has indicated that it is pausing its rate increases, but may resume them this year. No one knows for sure what will happen, but it would be frustrating to lock in a chunk of cash in a five-year certificate at 3 percent, only to see longer-term CD rates climb to 4 percent. So laddering can offer flexibility in the face of uncertainty.
Rates at online banks are well above the average of 0.98 percent for one-year CDs over all, and they at least mean savers aren’t losing money to inflation, said Greg McBride, chief financial analyst at the website Bankrate. (The Consumer Price Index, a widely used inflation gauge, has hovered around 2 percent for the past few years and was 1.6 percent in January, the federal Bureau of Labor Statistics reported.)
Most big, traditional banks still aren’t offering much in the way of interest on either savings accounts or CDs. “The larger banks continue to be pretty stingy,” Mr. McBride said.
Online banks, however, are competing for deposits to fund loans and credit cards. So you’ll see above-average rates from internet banks, including Synchrony (SYF), Barclays (BCS) and Marcus , the online consumer bank started by Goldman Sachs (GS).
One drawback to CD laddering is that you must keep track of the various certificate maturity dates and research interest rates before rolling your money into a new CD “You constantly have a CD maturing,” said Ken Hoyt, a fee-only financial adviser in Westford, Mass.
Doing the research means you’re not held hostage to a below-market rate. But ladders can be a chore to manage, he said, especially if you are juggling many certificates. “To me,” Mr. Hoyt said, “it’s more of a hassle than it’s worth.”
It’s wise to check the details before depositing your cash. Some higher-rate CDs have substantial minimum deposits, and there’s generally a penalty if you withdraw the money early.
Here are some questions and answers about CDs and laddering:
Q: Are CDs suitable for holding emergency funds?
A: That depends. Having money locked into a CD for a fixed period of time means you may be less likely to spend the money on nonemergency items. But penalties can be hefty if you need the cash quickly and withdraw funds before the certificate matures. Some longer-term CDs charge as much as a full year of interest. And if you withdraw your money so early that you haven’t earned enough interest to pay the penalty, some CDs will bite into the principal to cover it — meaning you could actually lose money on what’s supposed to be a sure bet.
“For a rainy-day fund,” Mr. McBride advised, “keep it liquid.”
Mr. Horymski suggested that if you thought you might need some of the money in the short term, you could still build a CD ladder — just use a high-yield savings account in place of the initial, one-year CD Many online banks offer savings accounts paying more than 2 percent, so you won’t be sacrificing much interest. That way, you can withdraw some money if needed, without fear of paying a penalty.
You can also build a ladder with fewer “rungs” if you prefer — you just may not get the highest, longer-term rates. One option may be to start with a six-month CD, and add CDs in six-month increments (12 months, 18 months, etc.), to reduce the length of time your money is restricted.
Q: Do all of the CDs in my ladder have to be housed at the same bank?
A: No. You can hold the CDs in your ladder at multiple banks to get the best terms possible.
Q: Can I ask for a higher rate, after I deposit cash into a CD?
A: Generally, no. Some banks do offer a 30-day window after you make an initial deposit during which you can get a higher rate. And there are two types of CDs that offer more flexibility, said Arielle O’Shea, a banking specialist with the website NerdWallet. “Bump up” CDs allow you to request an increase during the term of the certificate — typically just once. And “Step Up” CDs come with rate increases that occur automatically. The downside? You’ll generally get a lower rate to start with, she said.
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