With short term rates drpping and long term rates rising, some bank customer may be discovering that the certificate of deposit they hold is no longer earning a competitive interest rate. The problem that arises when the majority of an investors funds are tied up in one or two CDs. It may be beneficial to withdraw the money from the CD and deposit that into a new CD at a higher interest rate. The issue that complicates this decision is the early redemption interest penalty that is charged when an investors cashed in the CD before its maturity. These situations should be avopided by a little investment diligence.
A measurable benefit of investing in bank CDs is not just high yields and principal security, but the overall level of liquidity. Investing in CDs can afford investors the ability to gain access to their cash to capitalize on a changing investment climate or in the event of a short-term cash need, without paying significant penalties. While there will be interest rate penalties for early redemption, buying several different CDs with varying maturity dates will allow an investor in bank CDs to have access to their capital on a regular basis without early withdrawing penalties. This technique of different maturity times on CD accounts is called laddering.
CD laddering is a strategy that involves purchasing CDs with different rates and at different maturity dates. This produces a system where the bank CDs will be maturing on a regular basis. It is best to purchase CDs that mature in one-year intervals over a five-year period. But this is just the prevailing best method. It would be advantageous to an investor with limited resources to split the CD purchases into even two or three different maturities. Instead of having all of the money in two year it can be split into a five year CD and 6 month CD or any number of combinations. The strategy is to create a system where CDs will be maturing on a regular basis. But achieving some level of adding liquidity and flexibility by staggering the maturities is better than one large term investment that comes due all in the same year.
The idea is that, if interest rates rise, investors may be able to take advantage of higher rates by buying new bank CDs with money coming from maturing issues. This will also present the opportunity to have access to capital on a regular basis without early withdrawing penalties on the existing CDs. And even if rates fall, investors will have some protection because their overall portfolio of CDs should have a rate of return that is going to be higher than the curent market CD rates. The average yield on the CD portfolio should be better than for someone who is trying to time the troughs and peaks of the CD interest rate market.
A CD ladder requires the account holder to reinvest the maturing CDs periodically. This strategy makes it important to keep track of when the bank CDs are maturing so the account holder has the option to search other investment options and decide whether it is better to reinvest in another CD or place the money elsewhere. Keeping tabs on the best CD rates and the time horizon on your investments is always a dependable path to greater rates of return.
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