So you have some money to invest, and you know one of the safest ways to invest it is with a certificate of deposit, or CD. But you also know that CDs are locked into a certain period of time before you can access the money. If you try to withdraw it sooner, you’ll likely have to pay a penalty.
That’s where CD laddering comes in. CD laddering is a great way to be able to have money tucked away, but also have access to the funds at regular intervals. There are a lot of different ways to approach CD laddering, depending on the individual’s investment strategy.
Basically, CD laddering is a collection of CDs that are bought at regular intervals so that they’ll mature at regular intervals as well. So over the course of the CDs’ maturity you have access to funds on an ongoing basis.
For example, say you set up three CDs – one that will mature in 6 months, a second that will mature in 12 months, and a third that will reach maturity in 24 months. When the 6-month CD matures, you can either cash it out or roll it over into another CD.
Under this scenario, you regularly have a CD coming up for maturity. If you decide you want to only use a portion of the funds that become available at maturity, you could take out the interest that you’ve earned and roll over the principal into a new CD.
Financial experts recommend using a mix of short and long term CD lengths for CD laddering. If you have some that are shorter term with a lower interest rate and some that are longer term with a higher interest rate, you benefit because if you average out all the rates, it’s as if you had a longer term CD all along.
One of the keys to laddering is to roll over the short-term CDs to longer terms at a higher interest rate. You end up with several CDs with long terms, but they’re coming due at regular intervals. So although you invest in the long-term higher-rate CDs, you’re not necessarily having to wait three years for one to come due because you’ve always got one coming due at a regular interval.
CD laddering can also be useful as a combination of an emergency fund and investment strategy.
Consider this approach:
A person takes the money saved up for an emergency fund and instead purchases a 6-month CD once every month over the course of 6 months. When a CD matures, the money can either be used for emergency purposes or rolled over into another 6-month CD. Basically this creates a perpetual emergency fund, and the money that’s invested earns a higher interest rate than what would be earned in a savings account.
Of course, it’s less complicated to use CD laddering over longer terms, but it depends on what you’re trying to achieve. And, as mentioned earlier, a mix of both long and short terms is advisable.
To learn more about CDs in general and what types are available at BankFive, go to http://www.bankfive.com/home/personal-banking/cd. CD laddering could be a good option for your savings needs, but we do recommend consulting with a tax advisor before making any major financial decisions.