It's tough to be a saver now. While historically low interest rates make this a great time to take out a loan, today's savings account interest rates offer scant returns to those storing their money for a rainy day.
But if low interest rates have you down, a CD ladder can help boost your savings returns while still keeping your money relatively accessible.
The basics of CDs
The interest rates for CDs, formally known as certificates of deposit, generally beat those of savings accounts. While today's best savings accounts offer interest rates of less than 1 percent, CD rates can be more than double that depending on the amount invested and the term of the deposit.
But to get those higher interest rates, you have to be willing to lock in your money for a specified period of time. Generally speaking, the longer the term on your CD, the higher your interest rate will be. But taking out a longer-term CD can be risky if you may need to access that money before the term -- an event that will trigger a penalty that can erode your interest or even some of your principal.
Besides this, tying up all your money for that length of time may not be a smart move anyway -- especially when rates are as low as they are now. But a CD ladder is designed to take advantage of the rates of long-term CDs while ensuring you still have cash available at more frequent intervals.
Creating a CD ladder
The first step to creating a CD ladder is to determine how much you can invest. Although a CD ladder can be arranged so money becomes available regularly, it is still prudent to leave some emergency money in a savings or checking account that can be accessed anytime.
Once you know how much you plan to invest, consider how long you can afford to keep that money tied up. If your work situation is unstable or your income is irregular, you may want to consider CDs that mature more frequently.
For example, if you were to invest $3,000, you could purchase six $500 CDs that mature at three-month intervals. Another option would be to purchase several small CDs with shorter terms as well as a larger CD with a longer period as in the following scenario:
- $500 - 3 months
- $500 - 6 months
- $500 - 9 months
- $500 - 12 months
- $1,000 - 2 years
Compared to investing in a single CD, this strategy allows you to receive a higher return on your investment while gaining more penalty-free access to your funds. And once the shorter term CDs mature, they can be renewed for one-year CDs that will allow continued access to your cash every three months and a higher overall interest rate.
A CD ladder is one way to combat low savings account interest rates, but carefully consider your cash flow needs before you invest. Then, once you've determined your investment amount, shop around for the best CD rates for your terms and get ready to beat the low interest rate blues.