Knowing you have a large purchase coming up can be overwhelming. A down payment on a house for example? Or maybe you’re paying cash for a car because you don’t want to go into debt for it? That’s a lot of money that you have to come up with.
And with that type of savings taking longer than most, there are a lot of places where you can go wrong (or right!) on your savings path.
Luckily, there’s a relatively simple investment you can use when saving for large purchases that gets you better interest than a savings account, but isn’t as risky as the stock market.
What you should be looking at are certificates of deposit, or CDs.
CDs are essentially a low-risk investment that provides a good avenue for people who aren’t needing to access their money for a set period of time.
In exchange for putting your money away in a low-risk bucket until its maturity date, you get guaranteed interest after a set period of time. This type of CD is a called a traditional CD; however there are less common types like Variable Rate (the rate changes based on an index) or a Jumbo CD (typically a minimum deposit upwards of $100,000).
CDs have received a less-than-favorable reputation lately because interest rates have been so low (less than 1%, and only slightly above if you choose a longer term), but these investments still have better interest than savings accounts. The only downside is that the account is not liquid like a savings account, so you do not want to use a CD unless you already have an emergency fund set up for unexpected problems.
Typically, CDs can start with as little as a one-month time frame but can go as long as 10 years. The longer time frame you choose, the better your rate of return. But with most types of CDs, once you lock in your rate & time frame, you’re set. If rates go up, you lose out. The flip side of this benefits you though: if rates decline, you’re able to keep the high rate you locked in at. .
But how can you actually use this strategy as a way to save for large purchases while making sure you can keep up with the best interest rates?
It’s actually quite easy, and it comes down to a strategy called CD laddering.
What exactly is CD laddering?
Well, it’s basically exactly like a ladder. Each rung represents a different CD.
Let’s say you’re doing a 3-year CD ladder and that, for simplicity’s sake, you have $10,000 to invest.
Take that $10,000 and divide it in three. Invest equal parts in three separate CDs: a 1-year, 2-year, and 3-year.
When the first CD matures, take the final amount and invest it again in a 3-year CD. When the second matures, do the same thing with a 3-year CD.
The original 3-year account will then mature and get invested into another 3-year CD.
Using this method, every year one of your CDs matures which gives you the opportunity to reinvest your money. Conversely, if a financial situation arises that requires a large sum of money, this allows you to have points where you can take your money out without facing an early withdrawal penalty.
Especially in the current situation where rates will likely either stay steady or rise (simply because they are so low already), investing in a new CD each year will allow you to always take advantage of the best rates.
And ultimately, that will help you save up for larger purchases or down payments more efficiently than just putting money in savings.
Saving in CDs isn’t a good option for every situation though. There are limitations, namely the low interest rate. Depending on where you’re at in your retirement savings, you would likely want to choose an investment with a higher chance of return if you were looking for long-term gains.
But there are plenty of shorter-term things you can use CDs for like down payments.
Not only will the CD generate interest safely, but it also stocks your money away in an investment you can’t really touch (either that or you pay a big penalty). Knowing that the money is there until it matures is a powerful piece of knowledge to help you stay committed to your goal. Because large purchases aren’t something you can get to quickly, having tactics in place to help keep you on track are essential.
There are quite a few apps that are available to do just that, whether it’s a notetaking app to provide reminders or a simple personal finance app like Mint, there are a lot available. A recent web app though that has taken a social approach to keeping you on track – an app called ZigZig (www.zigzig.co). Essentially what the site allows you to do is to create and share with your friends what they call a “Zig”, or a savings plan that you commit to.
Just like a CD, you set your term, the amount you’re committing to, and ultimately what you are saving for. That commitment with a CD or a Zig (or creating a Zig to save money to put into a CD) is really the first step towards saving more money and being on your way to achieving your financial goals.
But ultimately, how to save your money depends on what your situation is. Do you have emergency savings, where are you at in your retirement savings, what do the interest rates look like on CDs, etc. Don’t think of this as a catch-all, this-is-good-for-every-situation investment. Yes, it’s good, but personal finance is just that – personal. But, that doesn’t mean you can’t take advantage of potentially strong options like CDs.