Today I am sharing a post from fellow blogger Trent Hamm, who blogs daily at http://www.thesimpledollar.com/. I really like Trent's posts. He is very down-to-earth and I have learned much from him. Today he was answering reader questions about investing, and while most of you (like me) don't have big chunks of change sitting around, I learned some things about CDs that I didn't know. If you have anything invested in retirement accounts, as we do, you know how depressed the market is right now....so here are some things to think about, at least for the short term:
CD “Ladder” by Trent Hamm
"A certificate of deposit (often called a CD) is something you can buy from a bank. CDs are usually sold at a particular length of time and at a particular interest rate.
Typically, people will go to the bank, buy a CD with a particular interest rate and length, and wait for that length of time. At the end of that length of time, the buyer gets their money back plus the interest earned on the money during that period. If you try to get your money early, though, you usually have to pay a stiff penalty.
So, let’s say you find a 1 year CD at your local bank with an APY of 2%. You put $10,000 into it. At the end of the year, you get your $10,000 back and get another $200 back in interest. You can set this up to happen automatically so that the $200 gets rolled into your checking account and the $10,000 goes to buy another CD. All you see is the $200 in your checking account each year.
So, what’s a “ladder”? Let’s say you buy one of these CDs at the start of each month for a year. This means you’ve spent $120,000 on CDs over a year.
At the start of each month, one $10,000 CD matures, paying you $200 (assuming they’re always at 2% interest). That $10,000 then automatically buys another one year CD. That way, when that month rolls around next year, the same exact thing happens again.
The problem with this approach right now is that the interest rates on CDs are so incredibly low that you’re not really getting much of a boost at all beyond what interest rate you can get for an ordinary savings account. As the economy rebounds, these rates will go up and, eventually, CD rates will exceed savings account rates by enough to make it worthwhile.
If you’re thinking of this option, I offer a couple points of advice.
One, don’t put all of your money into this CD “ladder.” Keep at least a month’s worth of living expenses outside of this in savings as an emergency fund so that you don’t have to sell a CD early.
Two, wait to start this until there’s at least half a percent between a one year CD rate and what you can get in your savings account. Since you have to lock away your money for a year, you shouldn’t do it unless you’re getting some reasonable compensation for it."
And thanks for keeping me #1 in the state in the cheap sally contest; much appreciated:
www.cheapsally.com/contest/tricia-cliff/
