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- CD rates are falling in anticipation of a possible imminent rate cut by the Fed.
- This means that CD rates of 5% APY are likely to decline and become less competitive.
- CD ladders allow you to get a good interest rate for longer, regardless of what happens to CD interest rates.
The best interest rates on short-term CDs are currently around 5% annual yield, but that may not last much longer.
The Federal Reserve, the central banking system of the United States, is expected to cut its interest rates as early as September, which will lead to lower interest rates across the board. Because CD rates are fixed, they are already falling in preparation for the Fed’s predicted rate cuts. But CD ladders can help you continue to earn good interest long after the Fed cuts rates.
CD ladders offer flexibility while securing high interest rates
CDs are a type of savings account. You put money into them for a set period of time and earn a fixed interest rate until the end of the term. This is great for locking in high interest rates, but it comes at the expense of liquidity; you can’t withdraw money before the CD expires without paying early withdrawal penalties.
A CD ladder can have several benefits for individuals planning their savings goals. “It offers flexibility while locking in favorable interest rates,” says Uziel Gomez, CFP®, AFC, founder and financial planner at Primeros Financial.
By opening a CD ladder, you can lock in a good interest rate for several different terms – even if interest rates have already dropped – without tying up all your savings for the entire term of the ladder. You can also choose which CDs still offer 5% interest, regardless of who offers them.
When developing a CD ladder strategy, Gomez says you should consider your savings goals for the next five years to see what might benefit from opening a CD. “If a client wants to renovate their home and they want to do it in a year, then they might want to spread the entire amount over a six-month term and then over a one-year term, just because you never know what’s going to happen in a year,” Gomez adds. This gives you a little more wiggle room in case things happen a little sooner than expected.
Building a CD ladder with maturities of 5% or more
Currently, short-term CDs offer better interest rates than long-term CDs, so our example CD ladder is shorter-term. We only choose CDs from banks, since joining a credit union requires a few extra steps, and we stick with CDs that offer at least 5% APY.
If you have $30,000 and want to buy a home within 18 months, you could put $10,000 into each CD. Your 6-month CD will mature first; when it matures, you’ll get your first $10,000 back plus an additional $250 in interest. When your 1-year CD matures, you’ll get another $10,000 back plus over $500 in interest, for a total of over $750 in interest.
When your final 18-month CD matures, you’ll have all of your principal back, along with over $750 in interest from the 18-month CD alone—over $1,500 in total interest. Plus, you’ll have locked in a 5% interest rate on your funds long after rates are expected to fall.
CD ladders are not suitable for every purpose
Although CD ladders can be a good strategy to lock in high interest rates while maintaining liquidity, they are not suitable for every purpose.
“Everyone needs an emergency fund, so I wouldn’t recommend putting all your savings in a CD account because people are going to need that liquid flexibility,” Gomez says.
For emergency funds, savings accounts with high interest rates are better because you can withdraw money from them at any time. And for long-term savings goals that can withstand market fluctuations, investments may be a better fit.
