Certificates of Deposit CD Ladder

This article addresses an investment strategy known as a CD Ladder. With the uncertainty in today’s economy, many investors are taking a second look at certificates of deposit as a part of their investment and/or retirement portfolios.  Certificates of deposit (CDs) offer the advantages of guaranteed interest rates, guaranteed return of principal, and the security of FDIC insurance.

On the flip side, the disadvantages of certificates of deposit include relatively low interest rates and not having access to your money until the CD matures.  These disadvantages compound one another when you consider that to get higher returns on certificates of deposit, you have to invest in longer terms…typically 5 years.

There is, however, a strategy that allows you to enjoy the advantages of certificates of deposit, while minimizing the disadvantages of certificates of deposit.  The strategy is called a CD Ladder.

Here’s how it works.  Suppose you have $25,000 you want to invest in certificates of deposit.  Rather than investing the entire $25,000 in a single certificate of deposit with a single interest rate and maturity, you break it down into 5 separate CD units of $5,000 each.  You invest each $5,000 unit in a separate certificate of deposit with the following maturities: 1 year, 2 years, 3 years, 4 years and 5 years.

When the first certificate of deposit matures in one year, you reinvest it in a new 5-year CD, and you continue to follow this pattern year after year…rolling each year’s maturing CD into a new 5-year CD.  Each year is a rung on the ladder.  So each year, you have a certificate of deposit mature, and you reinvest it in a new 5-year CD.  The goal is to eventually have 5 separate certificates of deposit with 5 year terms, but with staggered maturity dates.

There are two primary advantages of this CD Ladder strategy.

1. 5-year terms tend to offer the most attractive certificate of deposit rates, so each time you renew a CD, you are getting the benefit of the higher rate.  This helps to eliminate the problem of low interest rates on certificates of deposit.

 

2. Because you have a certificate of deposit maturing every year, you are never more than 12 months away from having access to a portion of your money.  This helps to eliminate the problem of long CD terms.

 
So if you would like to employ certificates of deposit as a part of your investment portfolio, this CD laddering strategy can help you enjoy the many benefits of certificates of deposit while limiting their disadvantages.

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