While the stock market often takes center stage in discussions about investment strategies, Certificates of Deposit (CDs) offer a more conservative yet reliable way to grow your money. Whether you're a seasoned investor looking to diversify your portfolio or someone new to the world of finance seeking a secure place to start, this blog will serve as your comprehensive guide to understanding, maximizing, and benefiting from the often-overlooked but valuable investment tool known as Certificates of Deposit. Join us as we explore the ins and outs of CDs, their advantages, and strategies to make the most of this low-risk, interest-bearing investment option.
What is a CD?
A CD, or certificate of deposit, like a savings account, is insured by the NCUA for credit unions and by the FDIC for banks. They offer higher rates of return on your money than a savings account, in exchange for keeping the money invested for a fixed time frame (typically six months or more). Here at Arbor Financial we offer terms from 6 months all the way to 10 years. The intent is for the CD to be held, and not touched, for the chosen term. Upon maturity of the term, the money may be withdrawn along with the interest that was earned.
Is a CD a worthwhile investment?
The biggest advantage of a CD is the ability to grow money safely. Unlike the stock market, you don’t risk losing your principal investment and are guaranteed to grow your money at the agreed upon rate.* It is easy to calculate how much money you will earn with a CD calculator.
Additionally, in most cases a CD will yield a greater return than a savings account or a money market account. So, if you have money sitting in a cash reserve, savings, or low-yield money market account and you can afford to lock up some of your savings for a period of time, then a CD may be a good choice.
Questions to ask yourself before investing in a CD
- How much cash do I need? Savings accounts and money market accounts are liquid accounts, which allow you to access cash anytime you need it, without penalty. Before investing in a CD, which is non-liquid, you’ll want to determine how much money you can actually hold and how much you will need to have access to in a specified timeframe. Unlike many larger banks, you do not need a large investment amount at Arbor to get started. Our CDs have a $500 minimum and for our young members 12 and younger they can start investing with just $100.
- How liquid do I need my money? CDs with longer maturity terms will yield larger interest rates. So, if you’ve determined that you can you afford to park your funds for a longer period of time (several months or even years), a CD is worth adding to your investment portfolio.
Laddering = Liquidity
A CD ladder is a strategy that splits your investment into various CDs, each with varying maturity dates. This approach enables you to earn interest while maintaining periodic access to a portion of your invested funds. As each CD matures, you can purchase another higher-yield CD, continuing the cycle. Or, you can choose to access your cash.
To maintain consistent access to your funds as each CD reaches maturity, many individuals choose to deposit equal amounts into each CD. You can decide whether to renew each maturing CD, adjust the deposited amount, modify the term length to capitalize on different interest rates, or withdraw the funds for immediate needs.
Here is a step by step example of how to ladder your CD investments!
Step 1: Decide on the Total Investment Amount
Determine how much money you want to invest in CDs. Let's say you have $10,000 to invest.
Step 2: Divide the Total Amount into Equal Parts
Most people split their total investment into equal parts, usually into smaller amounts that can be comfortably invested in individual CDs. This strategy ensures predictable access to those funds as each CD matures. For instance, if you have $10,000, you can divide it into five equal parts of $2,000 each.
Step 3: Open CDs with Different Maturity Dates
Invest each portion of your money into separate CDs with different maturity dates. Terms can vary from months to years. The idea is to have CDs maturing at different intervals. Here's an example of a simple 5-year CD ladder using five CDs:
$2,000 in a 1-year CD
$2,000 in a 2-year CD
$2,000 in a 3-year CD
$2,000 in a 4-year CD
$2,000 in a 5-year CD
In this example, you have created a CD ladder with CDs maturing every year, starting from year one and ending in year five.
Step 4: Renew or Reinvest as CDs Mature
As each CD reaches its maturity date, you have the option to do one of the following:
- Renew the CD: You can choose to renew the CD for another term, which may be the same or a different duration.
- Reinvest in a new CD: You can reinvest the matured CD amount into a new CD with a longer maturity date. For example, if the 1-year CD matures, you can reinvest the $2,000 in a new 5-year CD, extending your ladder.
Step 5: Repeat as Needed
Continue this process over time to maintain your CD ladder. As you reinvest or renew CDs, you maintain a balance between shorter-term liquidity and the potential for higher long-term interest rates.
The benefits of a CD ladder include regular access to a portion of your funds, the opportunity to take advantage of rising interest rates, and a steady stream of interest income. It's a conservative investment strategy suitable for individuals looking for low-risk, predictable returns while maintaining some liquidity.
Each individual must consider their own financial and cash management strategies and goals. We offer several tools and services to assist you, including several online calculators that can help you compare different savings scenarios and Arbor Financial Wealth Management, which has helped many members review their investment options and take action.
*This statement assumes you do not withdraw your money before the maturity date of the CD.
**Annual Percentage Yields (APYs) earned on certificates are calculated by the actual daily balance method and are paid and compounded monthly. A penalty may be imposed for withdrawals before maturity.
