Teach Me Tuesday is back! I started it back up because 1: a friend called me out on not doing any more (sorry!), and 2: another friend was wondering what his options are for saving money. So, here we go!
Friend #2 asked me for some advice, because he knows I’m into personal finance. His general situation (which I’m pretty sure he doesn’t mind me sharing!) is that he’s currently contributing quite a bit to his 401(k), beyond the company match but not to the limit imposed by the IRS. He wants to continue to save money, but also doesn’t want it all locked away for retirement. He thinks he might want to have kids soon, and so would like to have his savings a bit more liquid. He figured he’d either lower his contribution rate and make up for it with contribution to a savings account, or just start putting more in savings instead of increasing his contribution rate to his 401(k).
I suggested that, instead of using savings accounts, he could try CDs. And even better, a CD Ladder!
True story: I was with my parents at the bank maybe 10-15 years ago, and one of the bankers kept trying to get my parents to buy CDs. And yep, I thought they were talking about albums. I’m not even joking. I think I asked my parents later, and that cleared everything up.
So what are CDs when we’re not talking about Compact Discs? They’re Certificates of Deposit. Basically, they’re a method of investing/saving money where you put a certain amount of money in for a certain amount of time and you’re guaranteed a specific return on your investment. How is this different from a regular savings account? Usually, you can get a better interest rate from CDs (which is an upside of CDs). With a savings account, you can usually withdraw your money whenever you want (assuming you haven’t exceeded your allowance of transactions in a given time frame, and have money in the account), and can save as little as you want at one time and overall (i.e. saving $100 a month, keeping a few thousand dollars at a time). With CDs, you must keep your money in the bank for the agreed upon amount of time, otherwise you’ll end up paying penalties and/or losing out on the original interest rate. And you usually have to put in a pretty big amount of money all at once (depending on the bank).
So here’s the deal. CDs can be pretty excellent for long term investments of a large chunk of money. But if you want your money a bit more liquid, so that it’s not all tied up for years, but you want to keep it in a CD long enough so you can get a decent interest rate, many financial smarties suggest using a CD Ladder. I will admit that I’m not as familiar with these as some more experienced personal finance bloggers. So I’m just going to link you to some good posts by them. I figure you can ask them for more help. The basic gist of these is that you spread out your investments in some shorter term CDs and longer term CDs so that you take advantage of the higher interest rates of some while making sure you haven’t locked yourself out of all your money. And once you’ve set up a CD Ladder, you can continue using that method year after year.
Two good places for advice on how to do a CD Ladder:
CDs and CD Ladders aren’t for everyone. When should you NOT do CD Laddering? If you don’t have enough money to be comfortable having a certain amount off limits. Also, if you know you’re going to need the money before the CD reaches maturity, you shouldn’t put it in a CD. Also, it’s possible that for your time frame, the rate on a savings account (or money market account) could be more than that of a short-term CD. So you’ll want to compare your options.
I’m not a certified financial planner, so this isn’t professional advice, merely me trying to spread some information that I’ve found from others.
I suggested that my friend do an automatic transfer into his savings on a regular basis, and perhaps buy a CD when he gets enough saved up.
What do you think he should do? Lower the 401(k) contribution while upping the savings? Or just up the savings? And have any of you done a CD ladder? Is the trouble worth it for the returns?