An Introduction to Certificates of Deposit (CDs) for Retirees

Artemis & Leto, Artemis and Leto, Certificate of Deposit, CD, CD ladder, CD laddering

A Certificate of Deposit (CD) can be a great investment vehicle for retirees, particularly for saving cash that doesn’t need to be extremely liquid

Disclaimer: We are not financial professionals, and this article is intended only to educate and inspire, not to provide specific advice about your specific personal financial situation (so don’t call the lawyers).

Part 8 of “How to Invest – Safely and Smartly – During the Retirement Years”

In a previous article we introduced Money Market Accounts and Funds. These are investment vehicles for cash (like a savings/share account). In this article, we cover another cash investment vehicle: the Certificate of Deposit, or CD for short.

What is a CD (Certificate of Deposit)?

CDs are cash products similar to savings accounts, except that you leave your the deposit alone for a specified length of time (maturity date). This makes CDs less liquid (you can’t access your cash easily/quickly) than normal savings accounts. Because of this, they come with slightly higher interest rates.

CDs are widely available at credit unions, banks, and investment firms. Shop around because rates matter here.

Fixed vs. Variable Interest Rates

Most CDs have a fixed interest rate, meaning that it stays the same over the life of the CD. So if it’s 3% when you first open the CD, it’ll stay 3% until it matures. This is a benefit because you know what interest rate you’ll be getting. But, when interest rates are lower (like they are now [June 2018]), you have to be careful not to lock your cash into low earnings. Interest rates could rise, then you’ll lose out on potentially higher returns.

Some CDs have a variable interest rate, meaning that it fluctuates over the life of the CD depending on broader economic conditions (such as changes in the prime rate [the rate that commercial banks charge each other for overnight lending – you don’t need to remember what the prime rate is, I’m just a nerd and like this financial stuff]). Anyway…so if the rate is 3% when you first open the CD, it will change (move up or down) over the life of the CD. 

CD Laddering

A classic strategy for fixed-rate CD saving is laddering, meaning to have your money in multiple CDs, each with different, staggered maturity dates. It’s easy to get bogged down in the details of CD laddering, so we’re going to address the critical highlights.

Why CD Laddering is a Good Idea

Why employ a CD laddering strategy? The main reasons are: 1) to increase the accessibility (liquidity) of your money, and 2) to take advantage of increases in interest rates while still ensuring a guaranteed rate of return (again, this is for fixed-rate CDs, not variable-rate CDs).

Setting Up a CD Ladder

There are two ways you could set this up: 1) buy x-number of CDs with different maturity dates on the same day, or 2) buy x-number of CDs with the same maturity date (such as every year) over x period of time. Then, depending on which method you used, you renew each CD based on the maturity cycle you want (such as, having one CD mature every year).

For example, let’s say you want to invest $100,000 in CDs. You want access to you part of your money every year. You might ladder your CDs as follows:

CD#1 = $20,000 in a 1-year CD

CD#2 = $20,000 in a 2-year CD

CD#3 = $20,000 in a 3-year CD

CD#4 = $20,000 in a 4-year CD

CD#5 = $20,000 in a 5-year CD

Then, after your first CD matures, you re-invest it in a 5-year CD. Repeat this pattern for CDs #2, 3, 4, and 5, until you have five 5-year CDs, one of which is maturing every year.

Final Thoughts

CDs are good investment vehicles for parking your cash safely. And, to maximize your returns, you should consider a laddering strategy. But, CD ladders do require that you pay some attention to them. As different CDs mature, you have to be on top of what has to happen next (“do I renew this one, or do I buy a new CD with a different maturity date?”). There are tools out there (spreadsheets, calculators) to help you organize and manage your CD ladders.

Personally, I’m too busy right now to worry about CD ladders, so I go with Money Market products. But, I don’t have much cash and I need liquidity (see Money Market article). Your situation might be very different, especially if you are a retiree who wants a chunk of cash safe from the stock/bond market (and earning at least some reasonable return).

     –Good luck, we’re all gonna need it!

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Feature Image Credit: lumix2004

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