Savers and investors that are looking for a short or long term savings options in today’s muddled investment climate may find the features and rates of return offered by certificate of deposit (CD) accounts are just the financial product that fits their needs. Most consumers are well aware that bank CDs are FDIC insured and their deposit and interest earnings are therefore protected.
With a fixed rate CD, the most common type of certificate account, the government insurance program assures account holders will get a guaranteed return for the term of the account holder’s choice. Common terms for CD accounts range from 3 months to 5 years, but shoppers can find CDs available for all sorts of maturities or time frames.
The biggest barrier to opening and holding CDs with many investors is they don’t know how long they should commit their funds to a new CD account. With most bank CDs, the early withdrawal penalty that is assessed for taking out funds prior to the maturity date will not only wipe out any returns the account holder may have accumulated but may even put the account in the red.
When comparing current CD rates, prospective account holders will notice that typically, the longer a CD’s term, the higher its interest rate. If someone knows they won’t need access to their money for a prolonged period, they might be more comfortable putting it in a long term CD with a higher interest rate. On the other hand, if an investor expects to need access to their money earlier, they might look for a CD with a shorter term and accept the lower rate.
However, many rate shoppers become concerned about the future path of rates. When they compare the best CD rates now they may find that rates have rises after they already locked in a fixed rate. To help balance the difference between long and short term rates with the investor’s time horizon, careful selection of the right CDs has to be made.
Given the large number of bank CD options available, account holders don’t have to accept stingy interest earnings nor do they have to give up liquidity. Many savers can earn higher yields on their CD accounts with a little research or with some slightly more complex approaches to holding these accounts.
Strategies like CD ladders or barbells can help increase returns and manage liquidity when opening and holding an account straight to maturity does not provide the necessary returns.
A CD ladder is a strategy where the investor buys or opens several CDs that mature at different intervals over an extended period of time. With CD laddering, the investor divides the total amount of money they want to invest into equal amounts and put it in CDs with different maturity dates.
By opening several CDs with staggered maturities, the account holder can take advantage of higher rates with longer term CDs, while enjoying added access to their money with shorter term CDs. Investors can not only maximize their potential earnings but they can also determine the frequency at which you’d like them available.
CD ladders can be constructed with short-term maturities, such as three months, six months or nine months or with longer terms such as 24 months or 60 month maturities. Changing the spread between account maturities can help manage liquidity along with helping to match the investor’s investment time horizon. There is no limit to the quantity or the frequency in a CD ladder, as long as the banking customer meets the minimum deposit requirements of their institution.
Changing the distribution of the very short terms and long terms of the ladder can lead to the creation of a barbell strategy. With a barbell strategy, the investor opens only short term CDs in addition to long term CDs. The short term CDs in a barbell strategy are reinvested once they mature, the quickly impending maturity times mean that the investor must reinvest the proceeds.
A barbell strategy is generally designed to take advantage of increasing interest rates. As the short term accounts of the CD portfolio are always being traded out as they reach maturity, when rates are rising the new CDs will pay higher interest than the maturing accounts did. And if interest rates fall, the long term CDs help save the overall portfolio rate of return because they’re locked in at the older, higher interest rates.
Investing in a CD can stabilize the overall return to the consumer without sacrificing too much liquidity regardless of how the account or accounts are held. With a good strategy and some patience, CD accounts can be the foundation of a solid financial plan.
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