Building a CD (certificate of deposit) ladder is a common strategy investors employ to benefit from CD’s high interest rates while still having access to their cash at set intervals. But setting up a ladder takes time and effort. Depending on how much money you're working with and the flexibility you need, another idea is buying parallel CDs – a few CDs set to mature at the same time -- instead of building an entire ladder.
What’s the difference and how do they work? A CD ladder consists of buying multiple CDs with staggered maturity dates: one one-year CD, one two-year CD, and so on. As one CD matures you get access to some of your cash while the rest stays invested. You can roll it into another CD or invest it another way. Buying parallel CDs is a much simpler strategy: you buy several CDs with the same maturity date. If you need to withdraw, you pay a penalty, but the hit you take with the fee is minimized since your money is invested in multiple CDs instead of just one.
CD ladders work best for long-term investors, while parallel CDs make more sense for someone who can’t commit to locking up all their money.
CDs offer relatively high interest rates compared to other types of deposit accounts. For instance, in New York, Citibank (Stock Quote: C) offers an interest rate of 2.4% on a $500 12-month CD and 1.01% on its $10,000 money market account. But the extra interest comes at a price: early withdrawal penalties.
Each institution is different, so make sure to learn about any penalties before buying a CD. For instance, Citibank charges 30 days of simple interest on any CD of 12 months or less, while Bank of America (Stock Quote: BAC) charges 90 days of interest on its 12-month CDs. The penalty from U.S. Bank (Stock Quote: USB) is the highest of the three, however, and includes a $25 fee in addition to half of the interest you would have earned on the money you withdraw. Some consumers might not be able to commit to locking up their money for so long.
Buying CDs in parallel can limit your early-withdrawal penalty by allowing you to sacrifice one CD while leaving the others in place. For instance, if you buy three five-year CDs at $2,000 each, and suddenly find yourself in need of money, you only need to cash out one CD, leaving the other two to continue earning interest. The early withdrawal fee on that single $2,000 CD would be less than what you'd pay if you tried to cash out a $6,000 CD.
While CD ladders help you sidestep these penalties by staggering the maturity dates of your CDs, it can take a few years before you are earning the maximum amount of interest. That might be fine if you are setting up a long-term plan to generate steady income, but it isn't as useful in the short term.
If you do plan on buying a set of parallel CDs, start your search online at BankingMyWay.com’s CD section. Enter your ZIP code to find the latest rate offers from local and online institutions alike.