A Certificate of Deposit, or CD, is a federally insured savings account. Unlike regular savings accounts, money cannot be withdrawn at any time. Instead, funds must remain in the investment for a set amount of time of 3, 6, 12, 24, or 60 months. In return, investors receive favorable interest rates and a regular monthly interest payout on their investment if they choose.
CD investments will have a maturity date, and investors should keep the funds invested until that date arrives. Early withdrawal, even if permitted, will always result in penalty payments.
There are many different types of CDs, including the following:
- Traditional CD
- Bump-up CD
- Step-up CD
- Liquid (or no-penalty) CD
- Zero-coupon CD
- Callable CD
- Brokered CD
- High-yield CD
- Jumbo CD
- IRA CD
- Add-on CD
- Foreign currency CD
Working with a qualified financial advisor is the best way to determine the best CD for your unique financial circumstances. This article aims to outline three potential CD investment strategies – not as investment advice – but as a foundation to begin discussions with your certified financial planner.
Strategy 1 – CD Ladder
In the ladder strategy, you invest in several CDs with different terms, each one of which forms a ‘rung’ on the ‘ladder.’ For example, a $5000 investment is split into five various investments:
- $1000 in a 1-year CD
- $1000 in a 2-year CD
- $1000 in a 3-year CD
- $1000 in a 4-year CD
- $1000 in a 5-year CD
When the first investment (the 1-year) matures, you reinvest the money, plus interest, into the 5-year CD. Then you do the same with the rest when they mature, resulting in a reinvestment every year into your long-term CD.
This strategy allows you access to funds if needed and takes advantage of the higher interest rates on the longer-term investments – the best of both worlds!
Strategy 2 – CD Barbell
With the barbell strategy, you only invest in the extremes: long-term CDs and short-term CDs.
A $5000 investment with a barbell strategy will be split as follows:
- $2,500 in a 6-month CD
- $2,500 in a 5-year CD
When the shorter-range investment matures, you do one of two things: 1) invest in another short-range CD at another bank, or 2) reinvest in the longer-term one. To determine the best option, you need to evaluate interest rates.
Barbell strategies are primarily used by investors waiting for interest rates to rise. The shorter-term CD is for you to access regularly and invest where the interest rate is highest, while your long-term CD matures with time.
Strategy 3 – CD Bullet
The bullet strategy aims to have multiple CDs mature within the same time frame. It’s an ideal strategy to save for something big like a wedding or buying a home. You take out multiple CDs at different terms, but you don’t begin them simultaneously.
Here, the $5000 can be split as follows:
- $2,000 in a 5-year CD
- $1,500 in a 3-year CD in the second year
- $1,500 in a 1-year CD in the fourth year
The aim is to stagger the investments, which results in close maturity dates. Since CDs give a great interest rate but are often restrictive of adding funds regularly, this is a great way to get around it.
These three simple but highly effective CD strategies can be a great jumping-off point for those looking to get their feet wet in investing. Be sure to always consult with a financial professional to evaluate the best options for your own circumstances. Happy investing!