How To Complete a CD Rollover: Your Guide
A certificate of deposit rollover is the process of transferring money from an existing CD into a new one as soon as it matures. It’s a way to reinvest the principal and/or interest for a new predetermined period of time.
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Investors can use this method to compound interest over time. Here’s what you need to know about CD rollovers.
How CD Rollovers Work
Rolling over a CD is a straightforward process. When you initially purchased your CD, your bank or financial institution opened up a designated account for it.
As the maturity date approaches, the bank might notify you that you have the option of reinvesting. However, some banks automatically roll over the principal and interest into another CD unless you tell them not to. Make sure you read the fine print on your CD account so you are aware of how your bank handles this.
A strategy called CD laddering takes the rollover process a little further. With a CD ladder, you maintain several different CD accounts at once, each with a different maturity date. This gives you access to some of your invested funds on a regular basis while you roll over the rest to maximize interest.
How To Roll Over a CD
Here are the steps you would follow to complete a CD rollover. This example will use a $10,000 investment in a CD ladder.
Open five CDs with $2,000 each and the following maturities:
12 months
24 months
36 months
48 months
60 months
When your 12-month CD matures, roll over the principal and interest into a five-year CD.
Repeat this process with each of the CDs as they mature to keep the ladder going.
Once all the original CDs have been rolled over, you’ll have five 60-month CDs. They’ll typically earn higher interest than shorter-term CDs, but you’ll still get access to your money each year. This is convenient in case you need the cash or want to explore other investment opportunities.
Are CD Rollovers the Right Strategy for You? What To Consider
While the mechanics of rolling over a CD are relatively simple, there are a few things to consider before you try out this savings strategy.
Your Risk Tolerance
Because it is at the low end of the risk spectrum, a CD also carries one of the lowest commensurate returns. If you are particularly risk-averse, a rollover would be an appropriate strategy. However, if you want a more aggressive investment strategy that seeks capital appreciation or growth, then current CD rates will most likely not be sufficient for you.
Interest Rate Yield Curve
A CD is an interest-sensitive investment. Its interest rate is influenced by the direction of both long-term and short-term interest rates.
Depending on the direction of interest rates — also known as the yield curve — rolling over 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.
Federal Reserve Announcements
The Federal Reserve is responsible for setting overall policy that influences interest rates. Markets are sensitive to announcements by the Federal Reserve on interest rate strategy. They will respond accordingly, sometimes with volatility.
If you’re considering a CD rollover around the time when the Fed is making interest rate statements, it might make sense to delay reinvesting. Consider if there is the risk of being locked into a lower rate for a CD with an extended maturity date.
Investment Time Horizon
CD rollovers are a good fit for you if your investment horizon is short-term. If you know that you’ll need money at a specified point in the future and don’t want to keep your funds in a checking account, then a rollover strategy is a sensible decision.
For a longer-term strategy, continually rolling over CDs might not produce the gains you’re looking for.
Alternative Investment Vehicles
Despite interest rates reaching their highest level in over 15 years, savings accounts 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 yields that far exceed even the best CD rates available. Corporate bonds and mutual funds might also offer better returns. These can be 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 move inversely with maturity dates: the longer the maturity, the higher the interest rate. Fluctuations in the credit markets or the general direction of the economy could result in your newly rolled-over CD having a lower rate than the one that just matured. Before you lock money into a CD, consider the movement of interest rates. Then decide which maturity dates would provide the highest return.
Pros and Cons of CD Rollovers
As with any investment, there are some pros and cons to be aware of.
Advantages of a CD Rollover
A CD rollover offers a number of benefits. Here are 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
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 into a low rate for longer-term maturities
Investment planning made difficult due to frequent fluctuation of rates
Better returns are likely possible with alternative investments
Lack of diversification
Final Take
CD rollovers or laddering can offer investors a low-risk way to achieve greater financial returns. However, consider the various factors involved, such as your investment goals and the likely rate of return, to make the most informed decision for your financial situation.
FAQ
Here are the answers to some of the most frequently asked questions regarding CD rollovers.
What is a CD rollover?
A CD rollover is when you take the money from a matured CD and put it into a new CD.
What happens to your CD if you do not withdraw it?
If you do not withdraw your funds and your CD reaches maturity, it may get renewed automatically after a grace period.
What happens to a CD when it reaches maturity?
Your bank may notify you when your CD is approaching maturity and you will have the option of cashing out or reinvesting. Some banks will automatically rollover your CD into a new one at the time of maturity.
Is CD laddering a good idea?
CD ladders can be a good idea as they are low-risk and provide investors with a steady flow of money over time.
Daria Uhlig contributed to the reporting for this article.
This article originally appeared on GOBankingRates.com: How To Complete a CD Rollover: Your Guide
