How to Setup a CD Ladder
With CD rates being so low, you may not think that investing in certificates of deposits are a good idea. However, if you want 100% guaranteed security on your principle, using a certificate of deposit can be a smart move. However, you don’t want to be locked in to low CD rates when CD rates could rise in the future. As such, setting a up CD ladder can make a lot of sense.
How Certificates of Deposit Work
Certificates of Deposit are a special kind of deposit account offered by banks and they are FDIC insured. This means that the federal government insures your money.
A CD offers a variety of different terms and rates. Typically, you get lower rates for shorter terms, and higher rates for longer terms. However, in exchange for the rate you receive on your money, your money is tied up for the set term. If you withdraw your money early, you typically forfeit the interest you earned, or pay some percentage of it as a penalty.
The typical terms are anywhere from 90 days, 6 months, 1 year, all the way to 5 years. Each bank has different minimums, but most CDs must be at least $100 investments. Some banks offer higher interest rates if you deposit larger balances, like $10,000 or more.
Setting up a Ladder
Now that you understand the basics of a CD, you will know why laddering is a great idea. Let’s say you have $10,000 to invest, but you’re leery about the low interest rates. You know they’ll rise in a few years, so you don’t want to lock up all your money at low rates. That is where laddering comes in.
In CD laddering, you invest a portion of your total balance in different maturity CDs. This gives you the benefit of higher returns on the longer terms, but gives you the ability to get your cash out sooner on the shorter returns.
Check out this scenario with your $10,000:
- $2,000 in 1 year CD at 0.50%
- $2,000 in 2 year CD at 1.00%
- $2,000 in 3 year CD at 1.50%
- $2,000 in 4 year CD at 2.00%
- $2,000 in 5 year CD at 2.50%
After 1 year has elapsed, you will get $2,000 back (plus interest) that you can reinvest. If rates have gone up, you can re-invest in a 5 year CD to get the highest rate now, say 3.00%. The ladder continues, since the original 2-year CD now only has 1 year left. You can continue doing this over time to keep your money safe while taking advantage of higher interest rates.
Readers: Have you ever invested in CDs? Would you consider using a CD Ladder to take advantage of higher interest rates?