In a recent post, I talked about how I keep some of my savings (including my emergency fund) in CDs, or Certificates of Deposit. Because I need to access that money now, I have to close a CD early. What I should have done to prevent that is to keep my money in a CD ladder. Here, I’m going to explain to you what a CD is, what a CD ladder is, and why I think it’s a good savings mechanism.
What is a CD?
As defined by Investopedia,
A certificate of deposit (CD) is a savings certificate with a fixed maturity date, specified fixed interest rate and can be issued in any denomination aside from minimum investment requirements. A CD restricts access to the funds until the maturity date of the investment. CDs are generally issued by commercial banks and are insured by the FDIC up to $250,000 per individual.
While CDs used to involve going to the bank and getting actual certificates that later had to be redeemed, now you can do this all online.
So let’s say you have $500 that you want to save for at least a year. Doing a quick scan of current rates, you can get a 1 year CD at a 2.3% interest rate. At the end of one year, you will have $511.50. (Sure, that might not seem like much, but it’s more than you will make from any savings account.) Yes, you could possibly make more investing, but investments come with risks, and this is a completely safe place to put your money.
With most CDs, you can get your money out before the term is up, but you will pay a penalty (often 6 months worth of interest on any CD 12 months or longer). The goal is, of course, to never need to break the CD early, but sometimes life happens.
What is a CD ladder?
When you create a CD ladder, you set up a series of CDs that mature at a set interval.
For example, maybe I have $4000 I want to put into CDs. Starting now, I put them into 4 CDs, a 3 month, a 6 month, a 9 month, and a 12 month. That way, every 3 months, I have $1000 (plus interest) available to me. If I don’t need that $1000, I then put it into a new 12 month CD, so it goes back into the pattern.
Note that interest rates are much better with CDs of 12 months or more, so those initial CDs of under a year might not seem like as great of a deal, but the goal is to get your ladder started and then get your savings rolling.
Maybe you’d like to have money available more often. Let’s start with $6000, to make the math easy. This month, you open 4 CDs – 3, 6, 9, and 12 month, each with $500. Then next month, you do the same, and once again the month after that. Now you have 12 CDs, with one maturing every month.
I know what you’re thinking. Keeping track of 12 CDs sounds like a lot of work. What if I forget to get a new one and suddenly I’m a month off?
CDs typically have at least two options upon maturity – roll the funds into another CD of the same length or close the CD and deposit the funds into a bank account. (Some will also give you an option to rollover just the initial funds and deposit the interest.) Yes, in the initial months of a 12 month ladder, you will have to be paying attention and rolling into a 12 month CD, but once that’s done, you’ve got a great ladder that will just keep growing!
I’m going to work to get my emergency fund back into a solid ladder. If the money is just going to sit in a bank account, I might as well be earning as much interest as possible. And let’s be honest, once it’s locked away, it’s much harder for me to spend on a whim and that’s never a bad thing!
So if you’ve got some money sitting in an account just earning a small amount of interest, look into CD ladders. See what your bank offers. Don’t forget to check out the early withdrawal penalties, of course, but if you’re looking to grow your money, this is a great, safe place to start.
Megan is a 40-something government employee in the Washington, DC area. She got interested in Personal Finance when she got out of college and realized that her paycheck wasn’t going to go as far as she had hoped. Since starting this blog, she has managed to buy a house and make a solid start on her retirement goals, and hopes to help others do the same. Here is her story:
In 2007, I was a gainfully employed 20-something with no debt but not a lot of knowledge about personal finance. It was a co-worker’s comment about Roth IRAs that sent me to the internet, searching for information. It was then that I realized that I really didn’t know a whole lot about personal finance and that my current financial situation was due a lot to inherent frugal tendencies, generous family members, a fear of debt, and good luck. While that was working for me, clearly I needed a better plan.
While I had no debt, I was also pretty much living paycheck to paycheck and not worrying about going over budget (I say this as if I had a real budget) because I had an emergency fund set aside to cover any overages.
Except that’s not what an emergency fund is for.
So I did a lot of research, read a lot of blogs, and decided that I needed a plan. I needed to budget. I needed to know what I was spending my money on. I needed to prepare for the future.
I decided to create a blog not only to make myself accountable to others but also to share the knowledge that I gained along the way. I’ve learned so much from my fellow bloggers, and I hope that my readers can find something useful in what I have to share as well.