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“You can get past the dead end. You can break through the ceiling. I did and so have countless others.”

Passive Income: Building a CD Ladder

Oftentimes the best passive income strategies are the ones with the lowest risk. As someone who’s focused on building his nurse practitioner business, I want money-earning opportunities that produce good returns and take as little effort as possible. 

Thankfully, it doesn’t get any easier than this. To tame inflation, the Federal Reserve raising interest rates ten times and 475 bias points since March 2022. While this has caused mortgages and other loans to become more than they’ve been in over 15 years, it has also brought back an old but effective passive income strategy: CD ladders.

In case you don’t know, CD stands for “certificate of deposit.” These are bank products where you agree to tie up your money for anywhere between 3 and 60 months in exchange for a guaranteed rate of return.

For years (while interest rates were low), you’ve probably seen CDs advertised on bank websites but ignored them because they paid virtually nothing. However, that’s recently changed. Since the interest rates offered by banks are correlated to the federal funds rate, CD yields have been surging.

If history repeats itself, then this could mean easy money. Similar to now, the Fed also raised interest rates back in the 1970s to combat inflation. Even though they eventually got prices under control, interest rates stayed relatively high throughout the 1980s and 1990s. That enabled millions of people to go to do nothing more than go to the bank, hand them their money, and earn 5% to 8% each year.

However, traditional CDs do come with a few issues. That’s why in this post, I’m going to show you how to optimize your returns through what’s called a “CD ladder”.

How Does a CD Ladder Work? 

What do I mean by “ladder”? Why not just go to the bank and open a regular CD?

Consider the following. Let’s say you’ve got $10,000 that you’d like to put into a 12-month CD that pays a 4% APR. If you give the bank your money, you will receive $400 at the end of the year.

Not bad… but there are a few problems:

  • You have to wait a full year to collect the interest payment.
  • If you need a portion of your money between and then, then you’ll have to pay a penalty to break your CD. Most banks will charge some or all of the interest you’ve accumulated so far. 
  • What if interest rates go up? The Federal Reserve has stated many times that they’re not done raising interest rates, and we may still see at least two more before the end of 2023.

This is where the CD ladder takes passive interest payments to a whole new level.

Instead of investing the whole $10,000 all at once, you’d instead buy four separate CDs:

  • A 3-month CD for $2,500
  • A 6-month CD for $2,500
  • A 9-month CD for $2,500
  • A 12-month CD for $2,500

From here, you’ll do the following:

  • Wait for the 3-month CD to mature. When it does, renew it for another 12 months so that it matures 3 months after your last CD (i.e., 15 months from the initial start).
  • Next, wait for the 6-month CD to mature. When it does, new it for another 12 months so that it matures 3 months after the CD you opened in the last step (i.e. 18 months from the initial start).
  • Repeat this process for each CD in the series as it matures.

By doing things in this way,

  • You’ll collect interest every 3 months instead of waiting 12 months.
  • You’ll free up capital every 3 months instead of waiting 12 months. This will allow you to reallocate your funds if necessary to other needs or investments if one comes along.
  • Since you’ll be renewing CDs every 3 months, you’ll be capturing the latest and greatest interest rates. Over the long term, this is going to give you a better yield than if you had just bought a standard long-term CD.

Plus, if you don’t need the interest, then there’s another good reason to use a ladder: compounding returns! Because you’ll be getting paid several times throughout the year, you can roll the interest into the next rung of the CD ladder and let your investment compound for even bigger returns with each new cycle.

Alterations Welcomed

Note that you can modify this strategy to fit your needs in any way you see fit. For instance, instead of every 3 months, you could do every 6 months for a total spread of 2 years. I typically choose 12 to 18-month CDs because those seem to pay out the highest interest rates.

What If Interest Rates Start Dropping?

Interest rates don’t stay high forever, so it’s reasonable to have a plan in place in case that happens.

First things first, confirm that rates will be going down – don’t guess. Listen to news recaps from the latest Federal Reserve meetings. The Fed is generally very public about its intentions to raise or lower rates over the coming year.

Once you’re confident, it’s time to modify your ladder. Instead of renewing for 12 months, try renewing for longer – 2, 3, or even 5 years. Yes, it will lock your money up for longer. But you’ll also capture that juicy interest rate for as long as possible while it’s still available.

Automate Your CD Ladders

You might be thinking, “Nice trick, but I don’t want to research CD rates every couple of months and mess around with keeping them organized.”

The good news is that you don’t have to. Some financial platforms such as Fidelity now offer customers the ability to order CD ladder packages. Not only do they do all the heavy lifting of putting your ladder together, but they also will take care of keeping it going by automatically rolling both your principal and interest earnings into the next rung of the ladder. How much more passive can you get?

CD Ladders Are Structured Easy Money 

Yes, I know … CDs are boring. They’re very unsexy. It’s not as if you’re going to double your money. But at the same time, you’re also not going to lose your capital.

For as long as interest rates remain high, the yields from a CD ladder are basically guaranteed income. And don’t forget – bank products carry FDIC insurance of $250,000 per depositor per bank. That means you and your spouse could each open CDs at two different banks and have insurance on $1 million in assets. How much more protection could you ask for?

Remember: Interest rates won’t be high forever. The Fed can change them whenever they see fit, and when that happens, it will mean going back to stocks and other risky assets. For now, do the smart thing and take advantage of these high rates while they’re available.

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