One of the silver linings of historic inflation and all the Fed interest rate hikes is that for the first time in years, you can make legitimate money on your cash.
That includes traditional savings accounts, U.S. treasuries, money markets and Certificates of Deposit (CDs). Picking the choice that’s appropriate for your financial situation, now involves real stakes.
However, the market is trending toward the idea that we’ve already reached peak interest rates — with greater and greater confidence.
What about CD laddering? Is that a favorable strategy to squeeze the most out of your savings? And is it an even better option than high-yield savings accounts if interest rates do decline later this year?
What Is a CD Ladder?
If you don’t need your cash in the near term, you can lock it into a CD and get a better interest rate than you would in a savings account.
However, there are at least two risks with a CD.
First, if you need to use the money for something before the end of the term you agreed to for the CD, you’ll get penalized.
Second, if you lock into an interest rate for a prolonged period — and then interest rates continue to increase — you could be stuck earning less interest than you would on the open market.
The first potential drawback of a CD is especially significant. Five-year CDs often allow you to earn superior rates compared to one-year CDs, for example. But then your money is locked up and not liquid for an extended period, barring penalties for early withdrawal.
That’s where the idea of a CD ladder comes in. A listener asked Clark about the idea.
Asked Shannon in Texas: “Can you please explain CD ladder investing and when it would be a good idea for someone?”
Let’s start by outlining the basic idea of a CD ladder.
“The concept of laddering in the simplest form is, you take your pile of money you can put into CDs and you divide it into five piles,” Clark says.
“Twenty percent goes into a 1-year, 2-year, 3-year, 4-year and 5-year CD. When the [money from the] first-year CD becomes available after 12 months, you then put it in a 5-year CD.
“That means 20% of your money is always one year or less away from being available to you. But by historical measures, you’ll be earning the highest rates [with the 5-year CDs].”
Why Now Is the Time To Lock in a CD Ladder According to Clark
Why would you put money into a CD that’s 4.75% when you can earn 5% or more in an online savings account?
Perhaps that thinking is correct. That’s if you expect interest rates to stay the same. In addition to earning a quarter-point less in yield, you’d give up flexibility in the form of the instant liquidity a savings account offers.
However, interest rates rarely stay put for long periods.
If interest rates are headed higher, you don’t want to lock yourself into a years-long CD that may offer inferior rates to savings accounts. However, if the Fed cuts rates, locking into strong rates is a good idea. Even if a CD offered a slightly inferior yield vs. a savings account.
Current Strategy: Lock Into Longer-Term CDs at 5%+ Before They Disappear
On a recent podcast, Clark pointed out that his current advice around CDs involves long-term savings that you won’t need in the next several years. He wants you to lock into longer-term CD rates now so that when the rate cuts arrive, you’ll look smarter and smarter.
He’s not currently advocating for continuously re-upping your CD ladder. Rather, he says you should spread your money between 1-year, 2-year, 3-year, 4-year and 5-year CDs. Or just do 1-year, 3-year and 5-year. That acts as a sort of diversification or hedge (as opposed to putting every dollar into a 5-year CD). However you divide up your ladder, Clark thinks it is worth considering putting as much money as you safely can into longer-term CDs while rates are still good.
You can view the current best rates for CDs via this Bankrate tool. You can still get rates well north of 5% on shorter-term CDs. Charles Schwab and Fidelity Investments, Clark’s two favorite institutions to buy CDs, still are paying nearly 5% on certain CD terms right now.
Interest rates have consistently declined for a long time now. Inflation is trickling down in steady chunks nearly every month.
“I think there’s an opportunity to lock in money that you can afford to lock in, into longer-term CDs,” Clark says. “Money you can afford to tie up, we’re in a cycle where putting as much as you can in five-year CDs will be more to your advantage than being in shorter terms or in savings accounts.”
Final Thoughts
If you have cash that you don’t need immediately, you can consider putting it into a CD.
Even though CDs are a safe place to park your money, there is always a judgment call on the best way to go about any investment. With interest rates likely peaking, Clark thinks it is an ideal time to capitalize on these rates. How? By creating a CD ladder that is more heavily tilted towards long-term CDs.
