Seasoned investors understand the power of compound interest. When stocks grow in value while paying dividends, reinvesting the profits into more shares accelerates the overall return. However, in a bear market that causes even defensive stocks to lose value, investors can apply the same principles to their personal returns on traditional savings accounts. Reinvesting personal returns on investments can help the best CD rates rival those of stock indices.
Personal returns, when reinvested with the highest CD rates, can create a savings ladder with substantial, guaranteed earnings over time. Instead of scraping together a large lump sum and hoping for a major upswing on the stock market, consistent savers can use a combination of high-yield savings accounts and CD investments to structure a profitable, accessible portfolio with virtually no risk. Beginning investors can use this strategy to build an emergency fund or a long-term nest egg. Many experienced investors already use this process as a backstop against volatile equities markets.
The Rule of 72
Expert savers understand the "Rule of 72." Dividing 72 by an investment vehicle's interest rate results in the number of years it takes for an initial deposit to double. Therefore, a CD with a guaranteed 3 percent interest rate doubles in 24 years, while a CD paying 5 percent interest doubles in just under 15 years. This equation assumes a single initial deposit, followed by automatic reinvestment of personal returns.
When banks are eager to attract new deposits, competitive CD rates can attract savers who might previously have placed their money with brokerages. Without statement and transaction fees to eat away at personal returns, savings accounts offer predictable growth. And with innovative industry agreements (called CDARS) monitored by the Federal Reserve Bank, CD holders can enjoy government insurance for up to $50 million of deposits and interest.
Dollar cost averaging
Investors with only a little to save each month can benefit by shopping for the best CD rates and for the highest savings account rates. Stock market veterans use the phrase "dollar cost averaging" to describe the process of investing the same amount of money on a given equity every month to help absorb unexpected dips in share value. Laddering CDs uses the same savings discipline to create a stream of accounts that grow consistently while offering windows of liquidity.
Rolling over a mature CD into another investment upon maturity gives investors the option of returning to the stock market after a period of instability. Likewise, investors can reinvest their original principal and personal returns into a new account at current CD rates. Either way, leveraging dividends instead of cashing them out can lead long term investors toward the highest possible gains.