Basics of a CD Ladder Strategy
A Certificate of Deposit, commonly referred to as a CD, is a financial product that is offered by banks and credit unions, which makes them a secure and safe place to keep money that you aren’t planning to spend anytime soon. To initiate a CD, there is usually a minimum amount you need to deposit.
A CD is different from other types of savings or money market accounts, because by agreeing not to withdraw any money during the term of the CD, you will earn a higher interest rate than other types of deposit accounts. A CD is a guarantee that you will get the return on the agreed rate regardless if interest rates fluctuate. A CD laddering strategy will allow you to invest with flexibility of terms and rates.
What is CD Laddering?
Before you purchase a CD, it is good to know about a common investment strategy, CD laddering, to help you potentially maximize your earnings. Laddering simply means that you hold CD’s with different maturity dates and annual yields.
Suppose that you would like to purchase a five-year traditional CD with an initial deposit of $100,000. Using a laddering strategy, you would to invest your $100,000 into five $20,000 CD’s with terms of five years, four years, three years, two years and one year.
Each year when your CD reaches maturity it will automatically renew at the same term as originally set. For example, a one-year CD will automatically renew for one additional year when it reaches maturity. Dependent on your financial situation and current rates, you can can also choose to move these funds to the term of your choice.
Continuous laddering allows you to earn higher interest rates on your money and provides you a greater flexibility with your investments. As they renew you will have frequent access to your funds as they renew each year and have the flexibility to take advantage of rate increases as your CD’s renew.
- Liquidity – Cash is available at more frequent intervals than buying one long-term CD.
- Better Interest Rates – Once the ladder is established, you get to choose longer-term CD’s that offer a higher interest rate.
- Peace of Mind – When interest rates rise, you will be able to purchase CD’s at the higher rates each year. If interest rates fall, the longer-term CD’s you previously purchased were purchase at higher rates.