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You might have heard the term “CD laddering” thrown around and wondered what it is and if it’s a smart financial move. Whether you’re a seasoned financial investor or someone who thinks CDs are only music and software, CD laddering is worth knowing about. But first, let’s discuss exactly what a CD is.
A certificate of deposit is the highest-yielding way to save money without leaving a bank. With a CD, you put your money in an account for a set period of time – usually one to five years – and in return for not withdrawing it during that time, you get a higher interest rate than you would on a checking or savings account; the longer the term, the higher the rate. The down side, of course, is that the rate is fixed for the term of the CD, so if rates skyrocket, you won’t be able to take advantage of them. In addition, if you do need to withdraw that money, you pay a penalty that can effectively wipe out any interest you may have accrued and even eat into your initial deposit. Enter the CD ladder – a way that allows you, to some extent, to have your cake and eat it too.
The CD Ladder
Let’s say you have $10,000 that you’d like to earn higher interest rates on with a CD. You might be tempted to simply put that money in a long-term CD to get the best interest rates, but what if rates go up while your money is tied up in the CD’s term? You might be missing out on interest you could be earning. That’s where a CD ladder comes in.
A CD ladder isn’t an object or product so much as a process. It involves buying multiple CDs, with terms ranging from short to long, and setting the dates so that every year, one CD reaches maturity. Here’s how it works.
Instead of purchasing one CD with your $10,000 at a 5-year term, you would purchase five separate CDs of $2,000 each. The terms would range from one to five years, with one CD coming due per year. Each year you can either take the matured CD and move the balance into your checking account, or reinvest it into another CD with a five-year term – which nets the most interest.
Benefits and Risks
The ladder continues to ensure that you’re getting the best rates while still allowing you access to at least part of your money once a year without early withdrawal penalties. The best part is that it can be done with smaller amounts of money, and smaller terms as well. As little as $1,000 can be used to start a CD ladder, with shorter terms such as three, six, nine, and twelve months. A ladder set up this way won’t get you rates as high as the longer-term CDs, but it will allow you to earn something on your money while still allowing access sooner than once per year.
Unlike the stock market, CDs are insured by the FDIC, so you won’t have to worry about waking up one morning to find that you’ve lost everything when the market took a dive. You will, however, need to plan your ladder carefully so you can have access to your money if you need it, whether every year, or every 90 days.
Once your ladder is set up, you merely need to roll your CDs back into the longest term as they mature. Depending on how many CDs you broke up the initial investment into, you’ll have interest income and maturing principal at a regular interval.
So Why Doesn’t Everyone Do This?
While a CD ladder is easy to set up, and just as easy to maintain, they’re not as popular as stock market investments for one simple reason: they’re not as lucrative. You won’t make quick money with a CD ladder, and the low risk means low returns, even for a long-term CD. It is a good option, however, for people who want low-risk return and low-maintenance investments.
There are a lot of options for your money. A CD ladder isn’t the fastest way to grow your nest egg, but it’s a good way to keep it safe and grow it slow and steady without worrying about any stock market volatility.
Author: Jeff Gitlen