3 smart CD investing strategies for savers
Certificates of deposit (CDs) are a popular tool for savers who want to earn a meaningful return on their cash. As you start investing in CDs, you'll notice that the main factor that plays a role in returns is time. In many cases, you'll earn a larger return when you're willing to lock your money up for a longer period of time. However, short-term CDs offer some of the top rates available right now, so it can benefit you to consider adding both to your financial plan.
And, putting all of your savings into longer-term CDs isn't always the best plan for your money — even when rates on long-term CDs are higher than the rates being offered on short-term CDs. After all, if interest rates rise while your CD is maturing, you'll be locked in and earning at a lower rate. With this in mind, savvy savers can use a few strategies to balance risk and reward as they invest in these unique savings vehicles.
Learn more about today's high CD rates here.
Three smart CD investing strategies for savers
Here are the three most popular CD investing strategies:
The CD ladder strategy
The CD ladder strategy consists of opening several CDs with different terms at the same time rather than putting all of your money into one CD. In most cases, savers maintain the same or a similar length of time between each rung.
For example, let's say you have $20,000 you'd like to invest in CDs. Following the CD ladder strategy, you invest in 1-, 2-, 3-, 4- and 5-year CDs, depositing $4,000 in each. When you do, your five-year CD will likely have the highest return because it's earning interest and compounding for the longest time period.
When your 1-year CD matures, you reinvest the $4,000 principal investment, plus any gains you've earned, into a five-year CD. Do the same with the two-, three- and four-year CDs as they mature. In doing so, you'll have a new 5-year CD grow to maturity every year. From there, simply continue to reinvest and take advantage of compounding gains.
Learn about the rates you could get on CDs today.
The CD bullet strategy
The CD bullet strategy is a compelling strategy for savers who are saving for a specific purpose, like a down payment on a house or a new car. The bullet strategy can be a smart move because it allows you to make investments over time and target the same maturity date.
Let's say you're saving to put a down payment on a new home and you've given yourself five years to do it. You want to save $10,000 in principle and use the interest you earn to help with closing costs and other expenses.
Following the CD bullet strategy, you would set a goal to purchase a new $2,000 CD every year. The first one you purchase would have a 5-year term, followed by 4-, 3-, 2- and 1-year terms. At the five-year anniversary of your first purchase, all CDs in the bullet will mature. This means your CD investments all become liquid at or around the same time, making it possible to purchase your home without any early withdrawal penalties.
The CD barbell strategy
The CD barbell strategy consists of splitting the money you plan to invest in CDs into two vehicles with significantly different maturities. One is a short-term CD and the other is a long-term CD. This strategy is particularly useful if you think an interest rate hike might be on the horizon.
Let's say you have $10,000 to invest in CDs and you want to deploy the barbell strategy. You would purchase two $5,000 CDs, and the first would be a 6-month CD and the second would mature in anywhere from five to 10 years, depending on your goals and risk tolerance.
You continue to reinvest your 6-month CD returns back into short-term options until an interest rate increase takes place. At this point, you can invest the returns from your six-month CD at a higher rate.
This strategy is a strong choice in an interest rate environment like the one we're in today. Right now, CDs are paying historically high returns. At the same time, many experts suggest another interest rate hike is on the horizon. Rather than missing out on the already high interest rates the market is offering, the barbell gives you the ability to lock in today's rates. At the same time, you can use the short-term end of the barbell to jump into higher rates if and when those become available.
The bottom line
It's wise to purchase CDs as a way to invest in your future. It's even wiser to do so using a tried and true CD investing strategy. Consider using one of the strategies above to expand your savings.
