Interest rates are trending upwards, which will be a huge relief for savers who are earning very little in their bank accounts. Consider using the CD Ladder strategy to position your funds for the best yields as interest rates continue to rise.
A CD ladder puts your cash holdings into a series of short-term or medium-term bank certificates of deposit with staggered maturities. As each CD matures in an environment of rising interest rates, it rolls over to a new CD at a new higher interest rate.
Consider working with a financial advisor on the CD ladder and other financial considerations.
Current interest rate environment
There is no question about where interest rates are headed. The direction is that interest rates have risen enough to slow the US economy, and now he’s up from the 8.5% level until inflation falls.
Since March, the Federal Reserve’s Open Market Committee has raised the prime rate four times to 2.25% after cutting interest rates to near 0% at the start of the global pandemic. Federal Reserve Commissioner Jerome Powell said, “My colleagues and I are strongly committed to this project and I assure you that we will continue to do so until the work is done.”
We expect rate hikes to continue between 0.25% and 0.75% in 2023, depending on inflation.
Effects of interest rates on CDs
An increase in interest rates by the Federal Reserve will lead to higher interest rates for depositors. The average interest rate on one-year certificates of deposit rose to 0.65% in September from just 0.14% in December. On the high side of that average, interest rates for 1-year CDs are currently as high as 3%. (All yields quoted here are expressed in one-year yields, known as “annualized yields” or APYs.)
As the Federal Reserve continues to raise rates, these CD payments will also improve. That’s where the CD ladder comes in.
A CD is a bank deposit account that pays interest for a set period of time as long as the depositor does not touch the money during that time. Maturity he ranges from 30 days to 5 years, and generally the longer the term, the higher the fee.
While rates are rising, short-term CDs are more favorable until long-term rates catch up and peak. For example, in the first week of September, his APY for 1-year CDs was as high as 3%, while his highest 5-year CD rate was slightly better, with an APY of 3.65%. By using short-term CDs, a saver can capture future Fed rate hikes as the CD matures, which can be carried over to newer certificates of higher value.
In addition to improving yields as interest rates rise, the CD ladder maintains investment liquidity. With staggered maturity dates, you’ll have access to cash if you need it.
CD ladder investment technique
A saver with $10,000 in cash can build a ladder like this:
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$2,500 for a 3-month CD that pays 1.75% APY
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$2,500 for a 6-month CD that pays 2.5% APY
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$2,500 for a 9-month CD that pays 2.05% APY
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$2,500 for a 1 year CD that pays 3% APY
As each CD matures, it can be rolled over to a 1-year CD. Each certificate pays 3% (or more if interest rates rise) and matures once every 90 days to maintain liquidity. Once the price peaks, you can choose to lock in a higher price for a longer period of time, up to 5 years. For example, in early 2000, some 5-year CDs had APY returns as high as 6%, but between 2005 and the start of the pandemic he ranged from 3.75% to 0.25%.
While the CD ladder helps maximize returns from FDIC insurance bank accounts, it rarely catches up with inflation as interest rates rise, and when interest rates peak, matured certificates tend to fall short of yield. Rollover to lower CD. For investors looking for growth over security and liquidity, equities and other more aggressive investments may offer better performance.
Conclusion
The CD ladder is a low-risk way to earn interest while maintaining liquidity. With interest rates rising, the CD ladder is a particularly solid investment at the moment as it allows you to keep reinvesting even as interest rates continue to rise.
investment tips
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If you need help building your CD ladder, consider finding a financial advisor. Finding a qualified financial advisor is not difficult. SmartAsset’s free tool matches you with up to three financial advisors serving your area. You can interview Advisor Matching for free to determine which advisor is right for you. If you’re ready to find an advisor who can help you reach your financial goals, get started now.
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A money market account is another low-risk option for storing cash while earning interest.
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A post about using this technique to take advantage of rising interest rates was first published on the SmartAsset blog.