CD rates have not been this high in more than 15 years. If you have money that isn’t working very hard, now is the time to take advantage of the CD investment laddering strategy. Here’s how to get the most returns today while maintaining flexibility for the future.
Juicy Yields Up for Grabs—But Not for Long
The average 5-year CD rates is currently around 4.3% APWI, four times higher than a year ago. Meanwhile, the one-year CD APY is more than 1.74%.
This disparity breaks the typical relationship between CD terms and production. A longer commitment often yields greater returns. So why is a one-year-old product better than its five-year-old competitors?
This is because interest rates are expected to change in the next few years. In 2022, the Federal Reserve raised its benchmark rate by more than 500 basis points amid 40-year high inflation. However, most experts expect rate increases to moderate within a few years.
In other words, the premium paid on the short-term CD covers the reinvestment. No one knows where rates will be 12 months from now when the products run out.
The Power of Compounding High Yields
The exponential income potential of compound interest is affected by higher rates. For example, depositing $1,000 into a five-year CD at 4.3% APY yields a total of $1,234.
Here’s how that balance accumulates year-over-year:
- Year 1: $1,043
- Year 2: $1,087
- Year 3: $1,134
- Year 4: $1,182
- Year 5: $1,234
The additional $234 may cost more. But the statistics start to get more interesting when you apply the higher principles over longer periods of time.
For example, $10,000 grows to more than $12,800 at a 4,300% dividend after five years. And $100,000 becomes approximately $128,500.
Takeaway? Time and compounding accelerate wealth building.
Laddering CDs Maximizes Return Potential
Given the outlook for budget rates and inflation, where should you invest money today to optimize current and future yields? The answer is probably CD laddering.
This is how it works…
Instead of locking all your money in one five-year CD, divide it into equal parts, taking into account different terms. As such, you can allocate:
- 1-Year CD: $2,000
- 2-Year CD: $2,000
- 3-Year CD: $2,000
- 4-Year CD: $2,000
- 5-Year CD: $2,000
This structure takes advantage of today’s high short-term rates to enhance current returns. A “rung” on your ladder evolves every twelve months. At that point, you can turn it into cash or put it into a new five-year CD.
Your one-year CD will reinvest at a lower yield as rates fall. But your long positions continue to give good returns based on legacy rates.
Overall, CD laddering helps maximize earnings in rising and falling rate cycles. You enjoy higher short-term yields in the present and secure higher long-term returns over time. And you maintain access to cash flow as the pieces mature each year.
It’s an easy set-it-and-forget-it system that generates predictable interest income. At the same time, it takes advantage of the extremely rare opportunities to make money in today’s world.