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Certificates of Deposit (CDs) are safe, conservative investments. They’re a fine place to stick idle cash, though they can also be used for goal-directed saving.
When you open a CD, you deposit money with a bank and promise not to touch it for a certain period of time. Terms generally range from three months to five years. The longer you agree to let the bank use the money, the higher your rate of return. My credit union currently offers rates of between 4.30% and 4.90%, depending on the term.
However — and this is a big however — a CD is not as fluid as a savings account. Once you open your CD, you cannot touch your money until the maturation date. If you do, you’re subject to significant penalties that can conceivably eliminate any earned interest.
Returns on CDs aren’t spectacular, but they’re safe, sure investments. And in a period of rising interest rates, CDs become more attractive. A reader at CNNMoney says:
I’ve been pleasantly surprised at the recent rise in interest rates for CDs. What is the best way to evaluate the potential for CD rates to increase, and how do I know when it’s a good time to lock in a rate rather than waiting for rates to go up still more?
Money expert Walter Updegrave says that, as with playing the stock market, it’s really not possible to second-guess interest rates. But just as you can use dollar-cost averaging to profit from fluctuations in the stock market, you can use a “CD ladder” to profit from fluctuations in interest rates.
Say you have $5000 to invest. To build a CD ladder, you would invest the money in CDs with staggered maturation dates:
- $1000 in a one-year CD
- $1000 in a two-year CD
- $1000 in a three-year CD
- $1000 in a four-year CD
- $1000 in a five-year CD
As each CD matures, you immediately invest your money in a five-year CD, effectively maintaining the one-year stagger, or ladder. You won’t earn the best possible rate of return, but you will earn a good one, and your income will be relatively constant. The CD ladder is also a form of diversification: you’re not betting all your money on one interest rate.
I haven’t invested in CDs yet, but I suspect I will before this year is out.
For more on certificates of deposit, read how to ladder a CD portfolio at Bankrate (where you’ll also find this handy certificate of deposit calculator). Here’s a CD ladder calculator you can use to play with numbers.
July 25th, 2006 at 8:25 am
While rates are supposed to be really good on longer term CD’s, I never understand why people ladder them for a full year term. I prefer laddering them by month so that I get faster liquidity in the event of a crisis. It’s how I save my emergency fund, about 50% is liquid and 50% is in 6 or 9 month CD’s laddered to expire every 30 days over the next few months.
July 25th, 2006 at 10:07 am
But when INGDirect etc. are offering online savings rates of 4.35%+, why would you bother with a CD? It’s practically the same rate and you have much better liquidity.
July 25th, 2006 at 11:12 am
INGDirect makes setting up a CD ladder very simple — when you open a CD you have the option of opening one CD or a ladder.
Why invest in CDs? I use it for my emergency fund. If I need to use that money I will lose some interest if I cash it in. That will make me think twice before I cash it in and I won’t do that for anything that is not truly an emergency.
I ladder them for a full year so I only have to think about it once a year. I have the interest from each CD paid into a savings account each month (rather than paid at the end) along with additional $$ from every paycheck. At the end of the year I take the cashed out CD plus the money that has accumulated over the year in the savings account and open a new 5 year CD.
July 25th, 2006 at 12:04 pm
This is a popular (and safe) tactic, but I think most people are better served by utilizing a high-yield savings account and investing the majority of the emergency savings in the stock market. Emigrant Direct has savings accounts which yield 5% right now, so I can’t fathom a good reason for locking one’s money into a CD for any duration.
July 25th, 2006 at 12:30 pm
I’ve heard a lot about Emigrant Direct, though I haven’t researched the company myself. Do they have brick-and-mortar stores? Is this 5% interest rate fixed? Is it a true savings account, or is it a money market account of some sort?
CDs are appealing to me because:
* my credit union offers them, so I can keep dealing with the same people
* they have a fixed, guaranteed interest rate
* they’re an investment instrument I haven’t tried yet
Also: personally, I’d never put emergency savings into the stock market. It’s not very liquid (though perhaps just as liquid as CDs), and most of all it’s subject to much greater risk. I’m all for the stock market — no question — just not for an emergency fund. (But remember: DO WHAT WORKS FOR YOU.)
July 25th, 2006 at 3:18 pm
I’m with the folks who say it makes the most sense right now to just sign up with a high interest savings account. I’m making 4.35% at ING Direct and my buddy is making 5% at GMAC. I don’t see any point in investing in a non-liquid account that only has the same rate as a savings account. The “fixed, guaranteed interest rate” is nice, but, I expect interest rates to stay the same or increase for now, so I’m not worried about a sudden fall off.
July 26th, 2006 at 11:56 am
We do a ladder of CDs on a monthly basis as an emergency fund in the event that one of us gets laid off, hurt, sick, etc. The reason we do a CD instead of a liquid, high-yield savings account is simple: it’s a heck of a lot harder to spend the money in a CD, especially if you only get to touch it for a 10-day window, which is the case at my bank. You can bet we don’t touch those unless it truly is an emergency.
July 26th, 2006 at 1:01 pm
A few years ago my wife and I bought a car and were planning on paying cash. They were offering 0.9% APR on a 5 year loan, so we took that and put the cash for the car in a couple CD’s @ ING.
6 months later I closed all of the CD’s since the current APR in my savings account had already eclipsed all but the 4 year CD. I really only lost a few bucks from closing, and I made up the loss in a few months.
In these days when APR’s are going up so fast, locking into a CD really isn’t a great idea. If you’ve got $15K or more to invest, you can get about 5.3% in a money market account with checks at MBNA, which is only a hair less than most multi-year CD’s.
July 26th, 2006 at 1:49 pm
Duane,
I have real heartburn with the idea that you invest the majority of emergency savings in the stock market. The stock market by it’s very nature is volatile. You get better long-term returns but in the short-term, there can be some heart-stopping drops. Putting emergency money into stocks can be extremely risky and emergencies tend to adhere closely to Murphey’s Law.
Definition: emergency money is money you might need at a moment’s notice.
Lesson: don’t put a risk money that you might need at a moment’s notice.
July 27th, 2006 at 6:59 am
VinTek,
I’ll share with you some thoughts that JD and I kicked around in email concerning this topic. I hope it eases the heartburn a little.
My perspective toward stocks is likely tilted since I’m affiliated with an Investment Advisor firm. If the cushion is large enough (say, 6-12 months of living expenses) then there is always an issue you can liquidate if necessary. Very few life situations require tapping into the bulk of an emergency savings fund. In most cases you draw a little and then get back on track, or at the very least the draw is gradual and periodic. Both scenarios favor investing at least 75% of an emergency fund for growth.
I wouldn’t suggest this for everyone, and I don’t think it is particularly adventurous or risk-prone. The two biggest risks people face are continued employment and failing health. One always has to read the tea leaves, so to speak, about these risks. In other words, I believe a person should be more concerned about these risks than concerned about market risk.
August 1st, 2006 at 12:13 pm
You don’t want to invest in CDs in a rising interest rate environment. period. You’ll lock in a 4.4%, for 1 year or god forbid 5 years, then the Fed will raise the interest rate to 6,7, 8 or 10%, and a simple money market will pass your fixed rate CD account, and you will loose opportunity cost money.
You can get 4.4% from Vanguard for a money market right now, and can pull your money any time you want. Immigrant Direct is good i’ve heard as well.
So put your money in a good money market. Then you watch the Fed. When they stop raising interest rates, or start lowering them, get a CD. They regularly raise and lower at 25 basis points per quarter, so that’s the most you’ll miss out on. Then you’ll be locked in at a good rate 4.5 - 6% as the Fed lowers the interest rate back to 2%.
I also would avoid the stock market for an emergency fund. way too volatile, and the tax rate is high if you have to remove a large portion of it. Its an emergency fund. that means you want it ready to go when the floor drops out.
If you want to invest in the stock market, then split your account between emergency fund (however much you need) and stock market growth.
August 7th, 2006 at 5:56 am
[...] Investing Claire at Tired But Happy wants to start a CD ladder at ING Direct, but is unhappy with the “out-of-the-box” choices. She’s setting up her own manual CD ladder. (We discussed CD ladders here a couple weeks ago.) Her experience might help you understand how this investment idea works in real-life. [...]
November 1st, 2006 at 9:15 am
[...] If you know what you are saving and investing for, then you’ll be able to determine what kind of investments to get into. Service your short term goals with short term vehicles such as money market funds, liquid or no-penalty CDs, CD laddering, and short-term to medium-term bond funds; long term goals can be addressed by stock funds, equities, long-term bond funds, REITs and more aggressive investments. [...]
March 19th, 2007 at 4:17 pm
[...] To Build A Treasury Bill Ladder: A Visual Guide ยป My Money Blog I’ve written about CD ladders before. This is a similar idea. (tags: investing investments [...]
April 3rd, 2007 at 7:41 am
[...] that is equally riskless…” High-return “riskless” investments include certificates of deposit (CDs) and money market [...]
April 16th, 2007 at 9:14 am
I was re-reading this article to send to a friend who asked me about laddering. I’m surprised that people are still down on CD laddering with rising interest rates. The whole point of laddering and staggering your CD’s is to take advantage of new rates as they come up. It’s why I prefer short duration CD’s in month terms vs year terms. The key like JD says, is to do what works for you.
June 4th, 2007 at 6:52 am
I use CD’s for my liquid fund. I set a CD up then when I need money I borrow against the CD then just pay myself back. It also builds my credit.
September 16th, 2007 at 11:07 pm
All kind of “investments” you are talking about are not investments at all ! Just think about inflation rate ! Forget it ! You can make money as long as you use your money your self to make money ! For example build a house and get return up to 100% in one year.
November 9th, 2007 at 11:57 am
Emigrant Direct is a real savings account, with no fees and no minimum balance, and they’ve been around for 150+ years.
https://www.emigrantdirect.com/EmigrantDirectWeb/login/LearnMore.jsp
January 31st, 2008 at 11:01 am
[...] buy protection?”, he wonders. Here’s how: Since ING makes it free and easy to open a certificate of deposit [CD], every time I see another interest rate drop coming, I just throw more money into a 6-12 month [...]