by Amy Lillard
A safe, interest-earning investment method to grow income. Sounds like all you need to know about Certificates of Deposit, or CDs. But it's really only the beginning.
The variety of CDs available to consumers has grown and is growing still. Advice on how best to use CDs as an effective investment strategy proliferates. And with the growing diversity, the advice on how to shop for the perfect CD becomes more complicated.
In a series of articles, we take a look at CD types, investment use, and shopping tips. In this article – how to wisely use CDs as investments.
A smart investment portfolio is not simply one of stocks and other flashy options. Instead, savvy investment strategies involve using fixed-income investments for at least a portion of the portfolio. A great bet for good returns? CDs.
But there's more to it than simply snapping up a few CDs from your local bank or online brokerage. To receive high yields from the interest-earning accounts of CDs, use a few proven strategies.
Interest rates vary from year to year, month to month. CD laddering is a way to take advantage of high interest rates, and mitigate the effects of lower rates.
To understand this strategy, first know that longer term Certificates of Deposit are almost always paid the highest interest rates. However, consumers don't want to get stuck in long-term CDs if interest rates will be higher in a few months or years.
Ladders work like this. In a three-year ladder strategy, a consumer invests $15,000 in three equal portions into three different CDs: a 3-year CD, a 2-year CD and a one-year CD. In the first year, one CD will mature, and the others will have one less year on their term. The investor will place the funds from the matured CD, now larger with interest, into a new 3-year CD.
In this strategy, a CD will mature each year, and be reinvested into the longer-term, higher interest CD. Investors always reap the benefit of the highest interest rates in the long-term CD, but do not lock their entire investment into one term and one rate. Interest grows and is compounded, and returns on the investment grow steadily.
In this strategy, a time goal guides the process. Investors will stagger purchases of CDs, all of which mature at the same time. By purchasing CDs at different times, however, investors will reduce the risks of missing out on higher interest rates. Often, investors opt for this option when saving towards a certain, time-oriented goal, such as college tuition.
Investors use some money to buy CDs with longer terms to take advantage of higher interest, and the remaining money to buy shorter-term CDs. This allows some degree of liquidity and takes advantage of rate changes. Similar to laddering, this strategy is less structured and planned out by time.
With all these strategies, investors must keep in mind current and future cash needs. A one- or two-year CD is useless if you will need money within a few months. Withdrawal penalties and hassles will result in lost money from the process.
Alleviate this stress by ensuring plenty of cash in savings and income. In addition, cater the ladder, bullets or barbell to your needs. If a 3-year staggered ladder won't work for you, arrange your CDs on three, six and 12-month rungs.
Research your CD options and investment goals thoroughly. Using one of these strategies can further enhance your returns and grow your income through CDs.