I am writing this post in early July and interest rates are fluctuating greatly. The core belief I have read in the financial media is that the Federal Reserve Bank will hold rates to their existing low levels and would gradually begin to increase them in early 2023. Recently, there is much confusion in the marketplace as U.S. Treasury rates have actually been declining, which has caught financial professionals by surprise. The reasons for the decline range from concern over the COVID-19 Delta variant to whether inflation will negatively impact the economy.
This post is focused on the money you keep in savings products in your emergency fund or basic savings account and does not relate to the money you have in your long-term retirement plans. How the long-term money is invested needs a different review and analysis that I believe should be obtained from a qualified financial professional.
So the key question for you is, “What can you do to get the best return on your savings and yet be flexible enough to be able to reinvest in case rates really increase? In this post, I will give you a strategy you can follow to accomplish this.
Refinancing Loan Obligations
Before we delve into the post I want to reiterate that if you have not as yet refinanced your home mortgage or personal loans to take advantage of lower rates — please do so before any rate increases take place. You should investigate how much you can save. A close friend of my mind recently refinanced his mortgage and was able to lock in 30-year fixed mortgage rate of less than 3%. This saved him several hundred dollars per month. If rates head higher he has locked in a very low rate.
Laddering Your Savings Maturities – A Strategy to Deal with Rising Interest Rates
A key strategy you can use to protect your savings against rate changes is to employ a savings ladder. A savings ladder is strategy where you invest in savings vehicles (e.g., certificates of deposit (CD) or other savings products) with staggered maturity dates so you can take advantage of normally higher rates on the longer-term vehicles without committing all of your money to one savings product.
With this strategy, your funds will mature at different times and you will have available funds more often than if you put all of money into a single long-term product.
Here’s an example of how to set up a savings ladder.
Let’s say you want to build a four-year CD ladder with four rungs. If you have $4,000 to invest, then you might choose to divide the funds equally into four CDs with different maturity dates (the rates were taken from bankrate.com on July 8th):
$1,000 into one-year CD with 0.60 percent Annual Percentage Yield (APY)
$1,000 into a two-year CD with 0.85 percent APY
$1,000 into a three-year CD with 0.85 percent APY
$1,000 into a four-year CD with .90 percent APY
When the first CD matures after one year, you can cash out or choose to reinvest it into another CD that offers a higher yield. Each of the other CDs that you originally opened will be one year closer to their maturity date. You would continue this process each year as long as you want to maintain the ladder. You have the option to open CDs with the same amount of money in each rung or with various amounts of money.
As you build your ladder, you’re not under any obligation to have your accounts with the same financial institution. If you have a chance to visit the Bankrate.com website you will see that comparison shopping can produce better returns for you rather than having all your money with one company.
Using a ladder can allow you to take advantage of higher rates on longer-term savings products without locking up all of your money. Also, if rates are rising, you can reinvest the money from the shorter-term rung. As with most all savings products you have will have access to your money if you need it but be aware of what each institution charges for early withdrawal penalties.
Summary
A savings ladder can help you build a predictable investment return. It also gives you the ability to potentially earn better returns than you would on a single short-term product, as well as the ability to reinvest a portion of your savings yearly. Before acting, carefully consider your reason for opening the ladder. It could be a great strategy for your savings goals in this uncertain environment.
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