Returns on certificates of deposit (CDs), savings accounts, and money markets have been abysmal for the last several years. But we are currently seeing CD rates starting to go up because of the overall increase in interest rates.
This is great news for savers. And it's especially good news for savers who don’t like a lot of risk.
But when interest rates seem to be going up on a regular basis, it can be hard to know whether to put your savings into CDs now or to wait until a more favorable interest rate comes along.
The chart below shows CD rates by length of time, from 2009 through today.
Here are three things to consider when you’re looking at the best CD buying strategies when rates go up.
CD Ladders Help Minimize Risk and Maximize Gains
One of the biggest psychological challenges when there’s a potential future gain is that we tend to wait and ignore what’s in front of us now, instead of taking the benefits of today’s opportunities.
CD ladders can help to overcome this mental barrier.
CD ladders can take several different forms, as far as how long you invest each amount of money, but the basic structure is always the same. You take a lump sum of money (the total amount you want to put into CDs) and you break it into even amounts to invest in different time horizons.
Here’s an example:
If you have $10,000 to invest, you can buy five different CDs at $2,000 each, which could look like this:
- CD number one will be a one-year CD
- CD number two will be a two-year CD
- CD number three will be a three-year CD
- CD number four will be a four-year CD
- CD number five will be a five-year CD
The shorter-term CDs will have lower interest rates but will come due sooner, allowing you to reinvest the money if there is a gain in interest rates.
Normally, the way a ladder works is that you take each CD as it matures and put that money back into a five-year CD, which has a higher yield. This means you have CDs maturing every single year and can take advantage of interest rates that have gone up.
There is no reason that you can’t ladder CDs on shorter terms, as well. CDs can mature as quickly as three months. But it’s important to remember that the shorter the maturity term, the lower the interest rate.
Even with CDs rates rising, sometimes the best CD strategy when rates go up is to invest as normal.
If your main goal is to protect the money you worked hard to accumulate and not to dip into it, then a ladder of CDs that has longer maturities can be helpful in order to curb the urge to tap into the money.
It’s important to know yourself with this strategy. For many people, it’s better to have their money locked up in longer-term CDs, than for it to be readily available. As Ben Franklin always said, “a penny saved is a penny earned.”
Shop around for the best CDs (it’s really worth it).
The CDs with the best rates are usually at online banking institutions. These are lower cost than brick-and-mortar banks and often pass the savings onto the customer in the form of higher interest rates.
Sometimes, though, you can get great rates by becoming a new customer at a bank. These are called teaser rates and can produce yields that are higher than just about anything else.
A note of caution here, managing a lot of different bank accounts can be a pain. Sometimes it’s better to take a quarter percent less interest and to stick with the bank you have. You have to decide what’s right for you.
Another interesting option is something called a bump-up CD. Both banks and credit unions offer these, and they give the owner of the CD an option to raise their interest rate (if interest rates are going up) at least one time before the CD matures. Typically, this doesn’t happen automatically, and you have to request it.
When interest rates are going up, you can often get better yields on CDs, and by sticking to a strategy of laddering and shopping around, you can beat the psychological traps that make you worry about missing out.