Investing in CDs with varying maturities
- A CD ladder is a great place to park emergency funds for a rainy day.
- Determining if a CD ladder is a good idea depends on the purpose of the funds.
- These days, you may actually get better rates with a savings account.
After three years of record-low interest rates, few advisers are pushing their clients to build CD ladders. It's a method of opening numerous certificates of deposit that will mature at various times, which allows investors to create a cash-flow scenario with new CDs maturing on a regular basis.
However, there are some cases in which investing in CDs with varying maturities remains a viable option, especially for people who want to keep their money safe, federally insured and easily accessible.
"The CD ladder is always going to be more attractive for the more conservative investor," says Marsha Baker, a CPA who teaches consumer finance at Lindenwood University in St. Charles, Mo. "However, I think a CD ladder is a great place to park emergency funds, no matter what your risk tolerance might be."
Who should stagger CD maturities?
Like Baker, Deana Arnett, a CFP with Financial Planning Services in Manassas, Va., says she recommends CD ladders for people who have a well-established cash reserve fund of about six months' income. Because such an emergency fund usually has more money than most people want to keep in a savings or money market account, Arnett recommends keeping one or two months' income in a savings account and investing the rest in CDs with staggering maturities.
However, current interest rates make the strategy questionable for many advisers. "It's not that building a CD ladder is bad. Rather, it is the poor yields on CDs," says Dirk Anderson, a principal at Human Investing in Lake Oswego, Ore.
For instance, core inflation is around 3 percent per year. But the average 12-month CD pays about 0.5 percent interest, the average 10-year CD pays about 2 percent and the average 20-year CD pays about 3 percent.
"CDs just won't keep pace with the increasing cost of living, and when rates do rise, CD holders will get crushed if they only have long-dated CDs," Anderson says.
Determining whether a CD ladder is a good idea depends on the purpose of the funds, says Kathryn Garrison, a financial adviser with Moss Adams Wealth Advisors in Seattle. For instance, someone who has many more working years ahead of them may set aside $60,000 as an emergency fund. The money can be invested into three-, six-, nine- and 12-month CDs. "If they are laid off, they have money coming due to cover living expenses every three months or so," Garrison says. "If a CD comes due and they don't need the money, they can roll it into another 12-month CD."
A midcareer worker who needs to pay for a child's college tuition can ladder savings into CDs that will mature as the tuition payments are due, Garrison says. And a retired person can ladder CDs over longer terms, such as six months, 12 months, 18 months and 24 months, in order to have a healthy cash cushion, she says.