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CD Laddering

CD Laddering

August 01, 2023

When accumulating savings, one should consider all avenues for potential return over a given time horizon. An important consideration for taxable assets unsuitable for long-term investments are certificates of deposit or “CDs”. A certificate of deposit is an illiquid form of savings that accumulates interest over a certain period or “term”. In contrast to a savings account, a CD cannot be touched for the duration of the contract without risk of penalties or lost interest. As a result, financial institutes can offer greater guaranteed returns for these contracts.

Each CD will have three variables to compare. These are: interest rate, contract term, and penalties. All three of these will vary by institution based on current market rates. At JPB-Financial we always have access to the latest rates and offerings to help facilitate comparisons and provide you with peace of mind knowing you picked the best option given your situation.

Once purchased you hold the asset for the given term period until it reaches “maturity”. At maturity, you receive your principal amount plus any interest earned. The total amount of interest earned depends on the term and rate. For those looking to achieve better returns than general savings, checking, or money market accounts provide, without worrying about the volatility and risk of the stock market, CD’s can be an ideal asset.

There are several drawbacks to be aware of such as:

  1. Federal Bank rate hikes expose you to interest rate risk.
  2. FDIC coverage is limited to $250,000, a CD past this amount exposes you to credit risk. Should the issuing institution become insolvent there’s a chance of losing capital.
  3. Inflationary risk – During periods of high inflation the inherent value of your fixed-rate CD degrades relative to more volatile investments such as stocks/bonds.
  4. No special tax treatments are offered to save money for local, state, or federal taxes.

Strategies such as CD laddering can be implemented to mitigate these risk factors. Spreading the cash investment across multiple CDs grants access to higher interest rates when the economic backdrop changes and minimizes liquidity issues as funds become accessible over differing terms.

As an example, we will create a 5-year CD ladder with 5 “rungs”, or CDs and use $600,000 in capital. This could be money being saved for a renovation or a downpayment on a new home. All rates are current as of August 1, 2023.

$130,000 into a 6-month CD at 5.00% APY (CIT Bank) [8]

$140,000 into a 1-year CD at 5.25% APY (BMO Alto) [9]

$100,000 into a 2-year CD at 4.85% APY (First Internet Bank of Indiana) [10]

$120,000 into a 3-year CD at 4.45% APY (Alliant Credit Union) [11]

$110,000 into a 5-year CD at 4.30% APY (Quontic Bank) [12]

Note that any CD’s under 1 year duration won’t yield the total interest as advertised. A 6-month CD at 5.00% APY translates to a 6-month return of 2.50%. Therefore, you’d receive the $130,000 and the interest accumulated, which would be about $3250.

As illustrated, all the CDs have different amounts, maturity dates, and durations. After the first six months, the first CD would reach maturity. At maturity you have two options: cash out the maturity value or invest it into a new CD with a higher yield.

Additional Resources:

[1] CD Ladder: How to Make One, Benefits, FAQ (investopedia.com)

[2] What Is a CD Ladder? - NerdWallet

[3] CD Ladder: What It Is And How to Build One | Bankrate

[4] How to Build a CD Ladder and Why | Marcus by Goldman Sachs®

[5] CD Maturity: What to Do With a CD When It Matures (annuity.org)

[6] How Certificate of Deposit (CD) Maturities Work (investopedia.com)

[7] What Is a Certificate of Deposit (CD) and What Can It Do for You? (investopedia.com)

Sources for current CD rates (as of August 1, 2023):

[8] 6-Month CD | CIT Bank

[9] High Yield Online Certificates of Deposit (CDs) - BMO Alto

[10] High Yield Certificate of Deposit | CD Rates | First Internet Bank (firstib.com)

[11] Certificates | Alliant Credit Union

[12] Certificate of Deposit: Get the Best CD Rates - Quontic