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Billions of dollars in cash are pouring into one of the most staid investments, the certificate of deposit, though many savers aren’t unlocking their full potential.
Balances in CDs swelled to $480.2 billion in February, up from $36.5 billion in April 2022, according to the Federal Reserve.
CDs are supersafe assets that pay out interest over a set period, like a bond. Some one-year CDs now yield a bit over 5%, according to Bankrate.com. Five-year CDs top out around 4.5% annually, nearly a full percentage point more than a 5-year Treasury note, and don’t have the purchase limits of an I Bond. (More on how to choose among them later.
High-yield savings accounts also pay nearly 5% interest at the moment, though yields could drop for savings and CDs later this year as economic conditions change. Rather than commit to a single five-year CD to lock in a high rate, financial advisers say it often makes sense to set up a CD ladder—a series of CDs that mature at progressively later dates.
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Laddering has gained traction due to inflation, Fed rate increases and market volatility. CDs, bonds and other fixed-income securities are being rediscovered by a range of investors searching for the best place to put cash.
Here’s how ladders work: Say you have $30,000 to invest, and want to make sure you have some of it available every six months. You could put $10,000 in a six-month CD with a 5% rate, $10,000 in a one-year CD with a 5% rate and $10,000 in a three-year CD with a 4.75% rate. Six months later, when the first CD matures, you can either reinvest the money into another three-year CD (because your next CD will mature six months down the road), or use it for expenses. If the interest rates are no longer favorable at that time, you can consider other assets.
Staggering CDs provides access to your cash at predictable intervals and softens the effects of fluctuating interest rates. "The ladder takes the guessing out of which way rates are going to go," said Steve Wiechel, a senior fixed-income adviser at Buckingham Wealth Partners.
You have $5,000 to invest. You could put all of it in a single certificate of deposit, which would earn interest at a fixed rate over a fixed term.
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Or you could split it into five $1,000 investments in a CD ladder.
In a ladder, each $1,000 goes into separate CDs with progressively longer terms.
Staggering the maturity dates gives you access to money at regular intervals.
As each CD’s term expires, you can either pocket your returns or invest them in a new five-year CD, extending your ladder.
In our example, you could invest each of the initial five CDs in a new five-year CD when it matures.
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You can make a ladder with any type of fixed-income assets, including CDs and Treasurys. The beauty is in the flexibility. You can customize your ladder’s timing based on your financial needs.
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Ladders don’t necessarily yield higher returns than a single CD. One-year CDs currently pay a higher yield than three-year CDs, for example. But if rates drop, laddering could put the investor in a better position than if they kept buying the shorter-term CDs. And by having multiple CDs spread over different time periods, investors will always have cash available, financial advisers said.
For CDs purchased from a bank, taking money out before the term ends can come with a penalty, typically equivalent to three to six months of interest.
Who is a CD ladder for?
Laddering makes sense for people who want to grow their wealth but who may need to access their money for expenses such as tuition, or those wanting to safekeep a down payment while they wait for mortgage rates to drop.
The strategy can be especially useful for retirees largely reliant on Social Security and their 401(k) or IRA savings. Laddering can help stretch fixed retirement incomes, financial advisers say.
"We want to make sure that they have cash available for their needs," said Lou Liberatore, director of research at Alexandria Capital, an investment and wealth-management company. "We don’t want to worry about selling stocks or selling a bond that might have fallen in value."
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CD ladders also make sense for those wishing to diversify their portfolios and insulate them from market volatility.
"It’s a great place to park money if you want to reduce your risk level, particularly if you’re trying to meet a specific goal," said Marcus Holzberg, financial planner at Holzberg Wealth Management.
How to choose a CD
The main factors in choosing a CD are the rate and maturity date, as well as verifying that it comes with Federal Deposit Insurance Corp. protection, which typically runs to $250,000. Advisers warn not to exceed that amount when buying a CD. They also recommend avoiding CDs that are "callable," meaning that their issuer has the ability to return your cash early and skip the remaining interest payments.
You can buy a CD either from a bank or through a brokerage. The key difference is that brokered CDs can be sold to other investors, while bank CDs cannot. If you buy a bank CD and it turns out you need the money before it reaches maturity, you will typically have to pay an early-withdrawal penalty. Brokered CDs, meanwhile, can be sold penalty-free, though you may have to sell them at a loss if interest rates have risen and their value has declined.
Mr. Wiechel said he favors brokered CDs because you can hold them in a single brokerage account and they can be sold relatively easily. He also finds that their yields tend to be higher, but says investors should shop around.
What about Treasurys or I Bonds?
There are alternatives to CDs to consider.
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Treasurys have the advantage of paying interest that is exempt from state and local taxes. So even when they yield less than CDs, the tax advantages may have you come out ahead. Treasurys may be a good choice for people who live in higher-tax states such as New York or California, financial advisers say.
I Bonds are inflation-protected government bonds, which yielded nearly 10% last year as inflation rose. They currently pay an annualized 6.89% for six months, but purchases are limited to $10,000 a year. A new rate is set May 1 and is expected to be lower.
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The comparison between I Bonds, Treasurys and CDs will shift depending on inflation, rates and how much banks are competing for deposits.
"Right now, CDs are very attractive," Mr. Wiechel said.