My wife and I have invested in CD’s in the past as a way to earn extra income. Back when rates on a certificate of deposit where over 4.00%, the process was easy. Now that rates are much, much lower, it is a little more difficult to earn any significant income.
One investment tool that I am now using to help maximize our returns is known as CD laddering. Leveraging this type of tool can help to hedge against future interest rates changes while providing a safe and secure investment option.
Building the CD Ladder
Building a CD ladder is fairly easy if you can understand the components of them. Basically you need a decent initial investment (probably a couple thousand dollars if you got it) to get started. Most of your time spent will be on researching the highest CD rates that are available to you. This is a very important step and can have a major impact on how much passive income you will actually earn.
The other important step in building a CD ladder is to break up your initial investment into equal parts. These smaller parts should then be invested into several certificate of deposit accounts that expire at equal intervals. These intervals could be 3 months, 6 months, 1 year, or any other time period that makes sense.
Here is the CD ladder that I built recently with a total initial deposit amount of just over $40,000. Notice how each CD has an equal initial deposit and the increment between accounts is one year.
- 5 Year CD
- Deposit – $8,015
- Rate – 3.00%
- 4 Year CD
- Deposit – $8,015
- Rate – 2.75%
- 3 Year CD
- Deposit – $8,015
- Rate – 2.50%
- 2 Year CD
- Deposit – $8,015
- Rate – 2.00%
- 1 Year CD
- Deposit – $8,015
- Rate – 1.25%
Daily Compounding Interest
The most important part of researching CD’s to build a ladder is the interest rate. The difference between a 12-month CD that pays 1.25% and 0.35% on a $8,000 investment could mean an extra $70 in interest per year. That was the case when I closed out an older CD that was paying less than a half of percent and moved it to one paying over 1 percent.
There is also another important option to look for if you can find it when researching certificates of deposit. Compounding interest should be your friend and if you can, look for CD’s that pay it daily. Some deposits compound the interest daily while many others operate on a monthly schedule.
I was fortunate enough to open all 5 of our CD’s listed above that compound interest daily as opposed to monthly (like my older accounts I closed out of). It is important to make your money work for you as fast as possible and daily compounding interest can help.
Monthly Earned Interest
Since I chose to build our CD ladder through my credit union, the interest is paid out from each account on a monthly basis. This earned interest is immediately deposited back into a high yield savings account. Once the first CD expires in 11 more months, I will take the original investment and the interest earned from all of my accounts each month and open a new 5 year account.
Here are the monthly earned interest results -
- 5 Year – $20.42
- 4 Year – $18.72
- 3 Year – $17.02
- 2 Year – $13.61
- 1 Year – $8.35
Total Monthly Interest Earned – $78.12
Each month I plan to provide details on the passive income earned through my CD ladder.
Final Thoughts
Investing in high yield accounts like a certificate of deposit offers many benefits. Most notably is the guaranteed fixed rate of return, provided the accounts are backed by the FDIC. On the downside, the return on a CD can be very low when interest rates fall. As a hedge against low interest rates, a CD ladder can be built to provide a higher rate of return and put your money to work for you faster.
What tips can you provide on building a solid CD ladder from past experience?
Related posts:
- How to Build and Grow a CD Ladder
- CD Ladders – When are They a Bad Investment?
- 5 Tips for Investing in a High Yield CD
- Earn Certificate of Deposit Interest Using Your Tax Return
- How Does a Certificate of Deposit Work?
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