For years, many people didn”™t pay a lot of attention to the interest rates paid on the cash portion of their portfolio. They didn”™t have a lot of reason to do so. Holding some of their assets in cash for potential emergencies was just part of “Personal Finance 101” and we were living through a prolonged period of historically low interest rates. The difference in rates paid across most savings accounts, money market accounts, and even certificates of deposit (CDs) was practically negligible.
Gosh, have things changed in the last year.
In March 2022, the Federal Reserve Board of Governors made their first of seven increases to the Fed Funds target interest rate last year. Recently, however, they adjusted their inflation-fighting tactic. After a series of 75 basis point increases, they downshifted to a 50-basis point increase, followed by a 25-basis point increase. While this doesn”™t signal a reversal of course as it is still an increase, it may be time to consider where best to place your cash before Fed policy shifts and you possibly miss out on an opportunity.
Many people I talk with are either using a liquid savings/money market account, or they are staying in the short-term CDs even though the annual percentage yields (APYs) are now generally greater on longer term CDs. Maybe they think they can time the top of the interest rates and lock into their preferred product/term at the peak of this cycle. Or maybe they are forgetting that when interest rates do fall, their savings/money market will quickly reprice downward. And those short-term CDs will be repricing not too long after that.
When that happens, they may wish they had considered a mid-term or long-term CD for at least a portion of their cash. Something to help them enjoy these higher interest rates long after the Fed policy shifts and banks get their reason to cut their interest expenses.
One tactic that has been historically used to manage both liquidity needs, and a desire to enjoy the higher CD rates that often come with longer terms, is known as a CD Ladder. A CD Ladder is a method of allocating your cash across multiple certificates of deposit of varying terms. For example, someone with $5,000 could set up a ladder that looks like the graph below.
The accompanying graph (which is for illustration purposes only) offers a simplification on how the interest earned is withdrawn, not compounded. Actual APYs will vary by financial institution, and by term, over time.
This CD Ladder concept allows you to always have one of your CDs a year or less from maturity, helping to mitigate your liquidity risk. If you choose to reinvest at maturity, you can rollover each into a 5-year term creating a schedule of eventually always having a five-year CD maturing in one year or less.
It is important to remember that while longer term CDs often reward you with higher rates, it is not always the case. Be sure to watch your bank”™s rates carefully. It may be recommended to consider a savings or money market account along with CD Ladder for immediate liquidity needs that cannot wait for each annual maturity.
CDs are not for everyone. While they can be FDIC or NCUA insured, depending on dollar amounts and account titles, they are not without other risks. Interest rates may not be enough to hedge against inflation and interest rate movements, up or down, cannot be guaranteed.
Also, some CDs have variable interest rates that can adjust throughout the term. Your earned interest may be taxable income. You may need access to more of your cash than you earlier thought. Most CDs have early withdrawal penalties. Be sure to talk with your financial advisor and local banker about what approach may be best for your individual needs.
Mark Sanchioni is chief banking officer at Ridgewood Savings Bank, with 35 branches across Westchester, Long Island and New York City.
