Build Your CD Ladder
Investing in certificates of deposits can be a great way to earn higher interest rates as compared to savings accounts and money market accounts. This article will teach about my CD ladder strategy.
While you could get higher returns on investment by investing in mutual funds or individual stocks, investing in CDs allows you to protect your principle and lock in interest rates.
Advantages of CD Ladders
CD ladders offer two advantages. First, one drawback to buying CDs is that if interest rates go up after you invest in a certificate of deposit, your money will be locked in at the lower interest rates. CD ladders help you to protect yourself against rising interest rates.
The second advantage to investing in CDs through CD ladders is that CD ladders help you construct your CD portfolio in a way to take advantage of the higher CD interest rates available in longer term CDs, while giving you access to part of your money on a more regular basis.
This article will provide you with what you need to know to develop a great CD ladder strategy.
Certificates of Deposits
Before I get into how to build a CD ladder, I want to make sure to explain the basics of CDs. Certificates of Deposits are bank deposit accounts similar to savings accounts. However, a certificate of deposit has a maturity date and a fixed CD interest rate. Common CD terms are 6 month CDs, 12 month CDs, 24 month CDs, 36 month CDs and 60 month CDs.
CDs typically offer higher interest rates in exchange for agreeing to keep your deposit in the bank for the given CD term. Also, most CDs are FDIC insured. Broker CDs are not FDIC insured, but if you stick to buying typical bank CDs, they are almost always FDIC insured.
When you invest in a CD, your money is locked in during the term of the CD. If you need to use your money to pay for something, you will have to pay a penalty to liquidate the certificate of deposit before the expiration of its term.
While locking in your CD interest rate for the term of the CD allows you to know with certainty how much interest you will earn, if CD rates go up during the term of your certificate of deposit, you will be stuck with your lower rate. This risk is why CD ladders are a great way to invest in CDs.
CD Ladder
As mentioned above, the reason to build a CD ladder is to protect yourself if CD rates go up. A common stock investing strategy is dollar cost averaging and I think that this is a great analogy for CD laddering. With dollar cost averaging, you purchase stocks a little at a time on a regular basis. This helps protect your money in the event that the stock price falls after your initial purchase. This is the same with building a CD ladder, except with a CD ladder you are protecting yourself from buying a CD a CD rate too low.
CD ladders help protect you from the lost opportunity of buying CDs in the future with higher CD rates. How a CD ladder protects you is that with a CD ladder you can deposit your money in various CDs (initially all having various length terms), and once your CD ladder is established all of your money will be in the longest term CDs which presumably have the highest CD rates. But, once your CD ladder is built, the best part is that every year one of your CDs will mature and you will have access to your money to either purchase another CD or to invest it in some other manner.
How To Build A CD Ladder
For this example, lets assume that you want to build a 3 year CD ladder using $15,000 of savings.
To begin building the CD ladder you would buy 3 CDs at $5000 each - $5000 in a 1 year CD, $5000 in a 2 year CD, and $5000 in a 3 year CD. Now, every year one $5000 CD with mature allowing you to reinvest that $5000 in another CD. However, now you can buy a 3 year CD every time a CD matures. And, after two years, all of your $5000 will be invested at the higher CD rates offered by 3 year CDs. However, because a new CD will be maturing every year, at the end of the two year period, you will also have access to $5000 every year.
This same process can be used for any given maturity term you are going for. If you wanted a 5 year CD ladder, you would initially deposit equal sums into a 1 year CD, 2 year CD, 3 year CD, 4 year CD and 5 year CD.
I hope that this article will help you to save money smarter. Do you have a CD ladder? If so, please share how you built your CD ladder.
Related posts:
subscribe to the 
follow The Debt Hawk on 
{ 3 comments… read them below or add one }
I understand the concept of the CD ladder for liquidity purposes, but could it make more sense just to keep it all in a high online savings account instead? Just seems like a lot of effort for little gains.
Craig,
The problem with most high interest savings accounts is that banks can lower their interest rates at any time. With CDs you can lock in a CD rate for a given period of time.
When I first opened my ING Direct savings account, I think I was earning 3% interest. But, now I am earning 1.25% APY. That is a big drop in one year.
Hawk´s last blog ..CD Ladder – How To Build A CD Ladder
Helpful article Debt Hawk.
May I suggestion a different, and what I believe is a better method? It’s called “The DVD Method To CD Investing” .
Financial Samurai´s last blog ..The Katana: Help Haiti If You Can 1/17