Investing in Certificates of Deposit with CD Ladders
August 7, 2009
Certificates of deposit will never offer the same level of returns that you can earn in the stock market but CDs do provide a guaranteed return, unlike stocks. A certificate of deposit gives you a guaranteed interest rate in exchange for agreeing to lend the bank money for a certain period of time. If you decide to withdraw money before the maturity date, you’ll almost always have to pay a penalty.
When making certificate of deposits part of an investing strategy, many people create what’s become known as a CD ladder. Using a “laddering” approach prevents you from investing all of your money into a long term certificate at a low interest rate, and then missing out on better investment opportunities.
Basically, you take the amount of money you have to invest and split it up into several, smaller amounts. For example, say you’re investing $15,000 into CDs. Instead of doing one CD for 5 years with the whole amount, you might do $3,000 in 5 different certificates with varying maturity dates. Not only does this give you access to part of your money at different intervals, but it allows you to get higher interest rates if the market conditions improve after a couple years of investing.
How to Set Up a CD Ladder
You start a ladder by purchasing several CDs at one time with different maturity dates. You might get a one year, two year, three year, four year and a five year CD. When you use this strategy, every year one of your CDs will mature, and you can then roll it over into another CD with a longer term if the interest rates are higher, or a shorter term if you are waiting for the market conditions to improve and interest rates to go up.
In the example above, if you invested $3,000 of your $15,000 in each of the one, two, three, four and five year CDs, you have a ladder with 5 rungs on it. When your first CD matures after one year, you can roll it into a five year CD, or a four year CD if you want all of your CDs to mature at the same time. Whichever length of time you choose for your CD is the length of time you can roll over each of your maturing CDs, so that you’ll have money available every year once they start maturing but you’ll never have all of your money locked into a long term, lower-than-market-interest rate investment.
Laddering CDs is a method people use to protect themselves against the fluctuations of interest rates, while still giving access to some of your money within a short time frame without penalty. If something comes up and you suddenly need some of that money, you will have access to it in a reasonable period of time and can avoid penalty fees for withdrawing investments prior to their maturity dates.
Trisha Wagner is a personal finance writer for DepositAccounts.com, where you can compare rates of checking accounts from dozens of banks in one place. Trisha writes regularly on the topics of personal finance and savings accounts.
All posts by Ben Edwards