What is a CD ladder?
A CD ladder is an investment strategy where an investor divides his money and then invest them into Certificate of Deposits (CDs) with different maturity dates. Basically, the idea here is to open multiple CDs at once with different maturity rates, instead of locking all your money in one CD.
You then renew each CD at the highest maturity rate. The final results will be a system where there is one CD that matures at the end of each time period you have chosen.
How to form a CD ladder?
Let’s say that you want to invest $9000 in CDs. Since you cannot withdraw your money until the maturity date, a CD ladder will be a great choice for you.
The first thing you will do is dividing your money into equal amounts. Let us say you want to invest in 3 CDs with a maturity rate of one year. In this case, each one will take $3000.
So, this is how you will build your CD ladder.
First year: You will open three CDs that matures in one, two and three years.
- $3000 in a one-year CD
- $3000 in a two-year CD
- $3000 in a three-year CD
Second year: A CD of the shortest maturity date will mature.
- You will renew the one year CD into a three-year CD
Third year: A CD with the next shortest time will mature
- You will renew the two-year CD as a three-year CD
At the end of three years, you will have three three-year CDs. The trick here is that only one of these CDs will be maturing every year and you will be renewing it as a three-year CD.
This will give you access to 33% of your money every year. You can then renew it and continue the game or withdrawal your money.
Benefits of a CD ladder
- Higher interest returns if you have the right mix of long and short term CDs
- There is less risk since you have a guarantee of a fix interest rate
- Access to a percentage of your money without penalty
- Better than having the money in a savings account
Disadvantages of CD laddering
Even if you are using a CD ladder, you are not making enough compared to what you could make if you invested the money in other types of investments. CD laddering can be beneficial for a shorter term.
There is a chance that some of your CDs will mature when interest rates are low. This will force you to renew your CDs at a low-interest rate.
However, This technique is not good for long term investments. You can take advantage of tax-free investment instead of using a CD ladder for the long term investment.
Final Words
CD laddering can be a great technique. It can help you capture good rates of returns while having access to your capital.
This technique can also protect you when the interest rate plummet. If your money is locked in different CDs with different maturity rates, there is a chance that some of them will mature when the rates are good. Thus giving you a chance to renew them at good interest rates.
