Want the Higher Interest Rate of 5-Year CDs but Need Liquidity? Consider CD Laddering.

Bank of America recently announced it will cut some of its rates on CDs this week, and The Wall Street Journal reports that other banks will follow suit in the coming weeks. BofA cut the average rate on its 5-year CD by 0.50% last week, so these new cuts will drive down the interest rates even further. In the last 6 months other banking giants such as Wells Fargo substantially reduced their rates as well. This most recent cut from BofA is expected to spur further rate cuts from other banks in the near future.

It’s not too late to purchase a long-term CD at a higher rate, but some people may be hesitant to buy a 5 or a 7-year CD because of concerns that they may need to access the funds between now and the CD maturation date. In those instances, CD laddering can help.

If you ladder correctly, you should be never more than a year away from getting some of your funds. For example, if you have $5,000 to invest, you would invest $1,000 in a 5-year CD (typically, the longer the term of the CD, the higher the interest rate). You would then invest $1,000 in a 4-year CD, $1,000 in a 3-year, and so on. When the first year is up, if you don’t need to use the money from your $1,000 1-year CD, you would reinvest it in another 5 year CD and you would repeat the process ever year until you have rolling 5-year CDs maturing every year.

Diversifying in this way guards against the risk that the current 5-year interest rate will be the best you’ll be able to get in a 5-year period. It also gives you some liquidity. While CDs generally have an early withdrawal penalty, if you have a CD maturing every year, the chances are much less likely that you’ll have to cash out a CD early and incur a penalty.

For the best information on current CD rates, click on the CDs tab above.