A Quick Guide to Certificate of Deposit RolloversHere’s what you need to know before rolling over your CDs.
A certificate of deposit rollover is the process of signing up for another CD account immediately following the maturity of an existing CD. Funds, including the principal deposit and any interest earned, are transferred, or rolled over, into a new CD account for another predetermined term.
Using this method, investors can generate large amounts of interest over time. By taking the process a little further and maintaining several different CD accounts at once, all with different maturity dates, depositors are using what is known as a CD laddering strategy or CD rollover. Here’s what you need to know about CD rollovers.
Are CD Rollovers the Right Strategy for Your Investment Needs?
Because the mechanics of rolling over a CD are relatively simple, perhaps the most important consideration in connection with renewing a maturing CD is whether this choice is the best investment decision for your situation. To answer this question, examine factors such as your investment objectives, your risk tolerance, the amount of money available for investing, the likely direction of interest rates and the rate of return offered by alternative investment vehicles.
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Your Risk Tolerance
Because it is at the lower end of the risk spectrum, a CD also carries one of the lowest commensurate returns. If you are particularly risk-averse, a rollover is an appropriate strategy given your investment objectives. If you want or need to engage in a more aggressive investment strategy that seeks capital appreciation or growth, however, then current CD rates will likely not be sufficient for you to achieve your desired goal of higher returns.
Interest Rate Yield Curve
A CD is an interest-sensitive investment. The interest rate it carries at any given point in time is influenced, depending on the maturity, by the overall direction of both long-term and short-term interest rates. Depending on the direction of interest rates — or what’s known as the yield curve — reinvesting a CD that has matured might prove to be risky if rates have declined since your original purchase. The returns received upon rollover will always be subject to fluctuations.
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Federal Reserve Announcements
The Federal Reserve is responsible for setting overall policy regarding interest rates. Markets are sensitive to announcements by the Federal Reserve on interest rate strategy and respond accordingly, sometimes with volatility. If you’re considering a CD rollover at a time when the Fed will be making an official statement on its interest rate policy, it might make sense to delay reinvesting, especially if there is the risk of being locked into a lower rate for a CD with an extended maturity date.
Investment Time Horizon
If your investment horizon is short-term, or if you know that you’ll need money at a specified point in the future but don’t want to keep your funds in a non-interest-bearing checking account, then a rollover strategy, pegged to an appropriate maturity date, is a sensible decision. If your strategy is long-term and based on capital appreciation and growth by seeking returns in the stock market or mutual funds, continually rolling over CDs, including engaging in a laddering strategy, would not fit with your objectives.
Alternative Investment Vehicles
Since 2008, interest rates have remained relatively low by historical standards. Currently, savings, checking and other fixed-income investments don’t provide generous returns. Even a high-interest CD can’t compare with returns that alternative investments could yield.
Some stocks that pay dividends on a regular basis carry current yields that far exceed even the best CD rates available. Corporate bonds, as well as mutual funds, for example, might offer better returns tailored to your specific objectives and willingness to assume more risk than rolling over a CD.
Maturity Dates and Interest Rates
In general, CD rates vary inversely with the specified maturity date: the longer the maturity, the higher the interest rate payable. Fluctuations in the credit markets or the general direction of the economy could adversely affect the current rates that you might earn on a CD that’s recently matured. Carefully consider the movement of interest rates, then decide which maturity dates would provide the highest return.
How to Roll Over a CD
Rolling over a CD isn’t complicated. When you initially purchased your CD, your bank or financial institution opened up a designated account for that particular CD. When the maturity date approaches, some banks will notify you that you have the option of reinvesting, whereas others will automatically invest the proceeds in another CD at the then-current rate unless you tell them not to.
Here’s how to roll over a CD, using a $10,000 investment in a CD ladder as an example:
- Open five CDs with $2,000 each, with ascending maturities 12 months apart. This way, you’ll have access to some of your money every 12 months as your CDs come to term and you’ll benefit from the interest-earning power of the longer-term CDs.
- When your first 12-month CD matures, you can take your money out or renew the CD to keep your ladder going.
- Once all the original CDs have been renewed, the ladder works automatically.
Consider the following factors and decide whether a rollover strategy would be suitable for your particular investment needs.
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Advantages of a CD Rollover
A CD rollover offers a number of benefits. Here a few key advantages that could boost your financial strategy:
- Low-risk option for investing
- Insured by the FDIC up to $250,000
- Easy to reinvest at maturity
- No variation or fluctuation on rate of return on existing CD
- Can tailor different maturities to your specific investment objectives
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Disadvantages of a CD Rollover
Before you commit to this CD strategy, understand the drawbacks of a CD rollover. Here are the potential negative features to consider:
- Low rate of return
- Risk of being locked in to a low rate for longer-term maturities
- Investment planning made difficult due to frequent fluctuation of rates
- Better returns likely possible with alternative investments at slightly more risk
- Lack of diversification
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CD rollovers or laddering can offer investors a low-risk way to achieve greater financial returns. Consider the various factors involved, however, such as your investment goals and the likely rate of return, to make the most informed decision for your financial situation.