What you need to know about CD laddering
When it comes to financial planning for your short- and long-term goals, saving and investing are key components to help you build wealth. But after the Great Recession of 2008, some investors may feel a bit skittish about locking up so much cash in an uncertain economy. So, what’s a savvy saver to do?
Luckily, there’s a strategy that can help you save and build wealth over time, while keeping some flexibility in your investment. By investing in certificates of deposit (CDs) and creating a “CD ladder” portfolio, you can get competitive returns on your deposits while being able to access funds if you need them.
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Read on to learn more about certificates of deposit and how CD laddering can benefit you.
What is a Certificate of Deposit?
A certificate of deposit (CD) is a way to save money and guarantee your original investment. It’s one of the safest savings options (Opens in a new tab), according to the U.S. Securities and Exchange Commission.
Here’s what you need to know: a CD is basically a savings account that holds a fixed amount of money for a fixed period of time. The length of your CD is called the term and you can open CDs with various terms, anywhere from one month to several years. When the term is up, you get the money you originally invested plus any interest it earned.
Typically, the longer the term length, the higher the interest. The catch? When you purchase a CD, you agree to keep your money in the account until the end of the set term, called the maturity date. If you withdraw your cash before the maturity date, you could face stiff penalties.
Also, while your money is in a CD, interest rates could increase (meaning more bang for your buck) but you wouldn’t be able to take advantage of them until the CD matures without paying a penalty.
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"A CD ladder approach can help savers build wealth with the added benefit of being able to access their money when the earliest CD matures."
What is a CD ladder?
Creating a CD ladder lets investors like you take advantage of the highest CD rates while still having access to your original cash and interest in the shorter-term (if needed!) when the earliest CD matures. It’s a win-win situation.
This approach typically offers more flexibility than traditional CD investing. For instance, you might be attracted to the higher interest rate of a long-term CD, but don't want to stash away your cash for that long. A CD ladder approach can help savers build wealth with the added benefit of being able to access their money as each of the CDs in the ladder matures, beginning with the earliest.
Using a CD laddering strategy, you set up multiple CDs so they mature at staggered intervals. By investing in CDs of various term lengths, you may get the benefits of higher interest rates, while also seeing a return on your shorter-term CDs sooner. A CD laddering approach could look like this:
Step 1: Split your money between CDs of varying term lengths. You can divide your investments evenly (like $1,000 in each CD) or mix it up.
Step 2: As the term of each CD ends, you can take those funds and reinvest them into higher-interest CDs (these will probably longer-term ones, such as 5 years).
Step 3: Reap the rewards of your investments! The end result of a CD ladder is a staggered series of investments that lets you take advantage of high-interest CDs, while still having some flexibility to access your funds as each CD term ends.
After your first term is up (in this case, your one-year CD), you’d reinvest the cash from that CD into a CD with the highest rate available in the market at that time, which is typically the CD with the longest term at the top of your ladder (in this case, your five-year CD). At the end of each term, you may be able to re-invest that CD as a high-yield CD. You’ll eventually reach a point where your ladder is made up entirely of long-term CDs, which may earn the most interest.
"You can build cash flow and get a return on your investment in a low-risk environment."
What you should know about setting up a CD ladder
If you’re interested in creating a CD ladder, you can pick and choose which terms (or length of time) you invest in. The key is to have a mix of shorter-term CDs, medium-term CDs, and longer-term CDs. When creating a CD ladder, think of how much cash you want to keep fairly liquid and how much you can put away for longer.
Using a CD laddering strategy, you can build cash flow and may get a return on your investment in a low-risk environment. CDs typically are less risky than other types of investments, while warranting a higher return than a simple savings account.
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How to purchase CDs and set up a CD ladder
Certificates of deposit are available through banks, though rates and early withdrawal penalties vary depending on where you purchase them from (for example, here’s a list of BMO CD rates). If you want to set up a CD ladder, all you need to do is purchase several CDs of varying terms, then continue to reinvest the CDs at the bottom of your ladder as each term ends.
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