Are you looking for regular income from your investments, along with a strong dose of safety? If so, a CD ladder might be the right choice for you.
There are plenty of reasons to set up a CD ladder -- a series of certificates of deposit with different terms set to mature at regular intervals. It can provide a guaranteed income stream, along with the security of FDIC insurance, so there's no risk of losing your money. A downside of CDs, however, is that you can't touch your cash until the CD matures. A CD ladder gets around this by providing access to a portion of your money at set intervals. For the basics on setting this up, read BankingMyWay’s article on CD laddering.
But to make the best use of your CD ladder, plan ahead to ensure that the interval between CDs matches your financial needs. "If you want your CD ladder to provide an income, decide at the outset whether you want it to be on a monthly, quarterly or yearly basis," says Dylan Ross, a certified financial planner and founder of New Jersey-based Swan Financial Planning. "Then set up your rungs so that the money is there when you need it."
If you set your rungs too far apart, you risk incurring an early-withdrawal penalty if you need to take money out of a CD before it matures. Those penalties can be as high as a few months worth of interest. But long-term CDs offer better interest rates than short-term CDs, so if you make your intervals too short, you risk missing out on extra income.
Fact is, interest rates on short-term CDs have fallen close to the rates you could earn on more liquid types of deposit accounts, such as money market accounts. For instance, residents of Arizona can get 1.03% and 2.32% interest on three-month CDs from National Bank of Arizona (Stock Quote: ZION) and Sunrise Bank of Arizona (Stock Quote: CBC), respectively. Those same banks offer 1.3% and 2.52% interest rates, respectively, for six-month CDs. Meanwhile, a money market account from Heritage Bank (Stock Quote: HFWA) in Arizona offers an interest rate of 2.0% without carrying early withdrawal penalties.
BankingMyWay.com has a number of tools you can use to determine your CD laddering strategy. The best place to begin is with a CD rate search, which lets you find and compare rates in your area. Use the CD Ladder Calculator to determine the overall benefit from laddering, while the CD Rate Calculator will show you how much interest you can earn on deposit based on different rates and maturity dates.
The ability to balance the desire for better interest rates with the need for liquidity is why a CD ladder makes such a useful investment tool. Just make sure you build the right CD ladder for your needs.