A CD ladder is a great financial tool that can be used to hedge against future interest rates. Since most certificates of deposit accounts are FDIC insured, building this type of investment is a safe and secure form of passive income. While a CD ladder can offer many advantages over other investment opportunities, there are a few times when they don’t make sense.
Here are a few reasons you may want to consider before jumping right into building a CD ladder.
Short Term CD Ladders
It is possible to build a CD ladder where one account expires every 3 months. Ally Bank, for example offers 3 month, 6 month, 9 month, and 12 month CD options. An investor could invest equal amounts into each of the 4 investment options and build a short term CD ladder.
Typically, the shorter the term on a CD, the lower the interest rate. In many cases, a high yield savings account from an online bank will pay an equivalent interest rate compared to the average short term CD ladder.
For example, building a $10,000 CD ladder through Ally Bank by investing in a 3, 6, 9, and 12 month set of certificate of deposit accounts would produce about $128.91 in interest after one year if properly managed. That same $10,000 invested in an online savings account through Ally Bank would return around $128.82 in interest. As you can see, the CD ladder only returned $.03 more than the high yield savings account.
Since savings accounts are usually more liquid of an investment (meaning you can get your money faster), it has the advantage of the CDs.
Low Interest Rates
Certificate of deposit rates are very low right now and there is no sign of them rising anytime soon. There are plenty of other investments that would return a much higher rate then even the most profitable of CD ladders. Investors who can handle a little more risk may want to explore other alternatives to put their money.
Blue chip dividend paying stocks, for example often have a yield between 2% and 5%. Procter & Gamble (PG), one of the worlds most respected companies currently offers over a 3% yield to its investors.
Stocks, bonds, savings accounts, and even some checking accounts may have better interest rates currently than a certificate of deposit. Be sure to do your research looking for the most competitive rate options.
Final Thoughts
High yield investments like certificate of deposits may not always fit the name they are given. With interest rates so low, it can be frustrating for an investor looking to put their money to work for them in a safe and secure place. Spreading your money out across multiple accounts by building a CD ladder can at least provide a hedge against future interest rates and increase your return on investment.
There are however certain times when a CD ladder still does not make a wise investment. Building shorter term CD ladders often produce such a low return that a more flexible savings account may generate the same amount of income. During times of low interest rates (such as a recession), the rate on a CD ladder can be well under that of other investments like dividend paying stocks. Finally, a CD ladder is not as liquid an investment as other high yield options like a savings account.
What downside risks do you see from creating a CD ladder as an income stream?
Related posts:
- The Benefits of Building a CD Ladder
- How to Build and Grow a CD Ladder
- Earn Certificate of Deposit Interest Using Your Tax Return
- 5 Tips for Investing in a High Yield CD
- 5 Reasons to Open a High Yield Savings Account
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Thank you for submitting this article to my weekly contribution. I hope to see another article in the next edition on Wednesday, 4 August 2010.
@ditchtheboss, Looking forward to learning more about your Financial Independence carnival.