February 17, 2023 | by Team Wellby
CD Laddering: What It Is and How It Can Help You
March 2, 2023
By Travis Sink
CD laddering is a strategy for managing the maturity dates and yields of a portfolio of certificates of deposit (CDs). The idea behind CD laddering is to stagger the maturity dates of the CDs in a portfolio so that some CDs mature and can be reinvested periodically rather than all maturing simultaneously.
This allows for a steady income stream and the opportunity to take advantage of changes in interest rates. Additionally, it allows for flexibility in case of an emergency since you have some CDs maturing yearly.
In this article, we will look at how to build a CD ladder, the benefits of flexibility and accessibility, increasing returns with your ladder, and goal-based investing with a CD ladder.
How to Build a CD Ladder
CD laddering is a strategy that divides an investor's initial investment into several different CDs with varying maturity dates. Instead of investing all their funds into a single CD with a fixed term length, the investor spreads their funds across multiple CDs with different term lengths.
The strategy of laddering CDs allows investors to balance the trade-off of liquidity and yield. By dividing their funds among CDs with various maturities, the investor can take advantage of the best of both worlds, having some of the funds locked for longer terms to earn higher yields and some of the funds invested in short-term CDs for more liquidity. Here are the steps to follow to build a CD ladder:
Step 1. Initial Investment
The initial investment can vary depending on the investor's goals and financial situation. The key is to choose the right CDs with the right terms and then divide the investment into different CDs according to the laddering strategy. For example, with an initial $5,000 investment, you would build your CD ladder by spreading out your deposits like so:
- $1,000 in a one-year CD
- $1,000 in a two-year CD
- $1,000 in a three-year CD
- $1,000 in a four-year CD
- $1,000 in a five-year CD
It's important to note when building a CD ladder, you should invest the same amount of money in each CD. This will ensure that your ladder is well-balanced and that you are not taking on too much risk with any one investment. Ultimately, the initial investment for CD laddering depends on the individual's financial goals and risk tolerance.
Step 2. Reinvest each CD after it matures
When a CD matures, the investor has several options for what to do with the funds. The most common option is reinvesting the funds into a new CD with the same term length. For example, as the CD matures, you can put that money into a new five-year CD. After five years, your ladder will have five five-year CDs, and one will mature each year:
- $1,000 + one year of interest in a five-year CD
- $1,000 + two years of interest in a five-year CD
- $1,000 + three years of interest in a five-year CD
- $1,000 + four years of interest in a five-year CD
- $1,000 + five years of interest in a five-year CD
Remember to monitor the interest rates of the CDs and adjust the ladder as needed. If interest rates have increased, you may want to consider investing in long-term CDs to take advantage of the higher returns. Additionally, consider adjusting the amounts invested in each CD to reflect changes in your financial goals or market conditions.
The Benefits of Flexibility & Accessibility
One of the main benefits of CD laddering is that it allows investors to adapt to changes in their financial goals or market conditions. Investors can adjust their investment strategy as needed by laddering CDs with different maturity dates. For example, if interest rates increase, an investor may invest in long-term CDs to take advantage of higher returns.
Another benefit is that it provides investors with a steady income stream. As CDs mature, investors can reinvest the funds into new CDs or use them for other purposes. This can be beneficial for those who rely on a regular income, such as retirees, or those who need access to some of their funds in an emergency.
Additionally, CD laddering offers lower risk than other options as the interest rate is fixed, and you are diversifying the maturities of your CDs, so you are not exposed to the same interest rate risk as you would be if you invested all of your money in a single long-term CD.
Increasing Returns with Your Ladder
Laddering CDs can help reduce the risk of interest rate fluctuations. As the interest rate on a CD is fixed, if the market rate goes up, the interest you receive on your ladder will not change, however, you will have some maturing every year, and then you can reinvest in the new market rate. This is one of the main ways of increasing returns with your ladder, but there are several other ways you can increase your returns:
- Invest in long-term CDs: As interest rates increase, long-term CDs may offer higher returns than short-term CDs. So, when a CD matures, consider investing in a long-term CD to take advantage of the higher returns.
- Monitor interest rates: Monitor and calculate CD ladder interest rates and adjust your ladder as needed. If interest rates have increased, you may want to consider investing in long-term CDs to take advantage of the higher returns.
- Ladder your CDs with increasing maturity dates: Instead of laddering your CDs with the same maturity date, you can ladder them with increasing maturity dates. This way, you can take advantage of higher returns offered by long-term CDs while still having access to some of your funds every year.
- Invest in High-yield CDs: Some online banks or credit unions offer a higher yield than traditional bank CDs. It is worth looking into them as they might offer better returns.
- Take advantage of laddering bonuses: Some financial institutions offer laddering bonuses to customers who invest in multiple CDs with different maturity dates. These bonuses can increase your returns even further.
Goal-Based Investing with a CD Ladder
CD laddering can be an excellent strategy for goal-based investing, as it allows investors to align their investments with their specific financial goals. Some examples of how this savings approach can be used for goal-based investing include:
- Saving for retirement: By laddering CDs with longer maturity dates, investors can take advantage of higher returns while still having access to some of their funds yearly. This can be useful for retirees who rely on regular income from their investments.
- Saving for a down payment on a house: By laddering CDs with shorter maturity dates, investors can access their funds in a shorter period. This can be useful for those who are saving for a down payment on a house and need access to their funds in the near future.
- Emergency Fund: By laddering CDs with shorter maturity dates, investors can have access to their funds in case of an emergency. The laddering strategy allows for the opportunity to have some funds available in case of an emergency while still earning a return on the rest of the investment.
- Education funding: By laddering CDs with longer maturity dates, investors can take advantage of higher returns while still having access to some of their funds yearly. This can be useful for those who are saving for a child's education and need access to their funds in the future.
- Tax-saving: CDs offer tax benefits, and by laddering CDs with different maturity dates, investors can stagger the taxes they need to pay on the interest earned from their CDs.
Though CD laddering provides you with a steady income stream, it's important to note that CD laddering is not suitable for everyone. It's best to consult with a financial advisor to determine if it's right for you and the best strategy to implement based on your goals.
If you're interested in learning more about CD laddering and how it could benefit your financial goals, our team of experienced financial advisors can help you determine if CD laddering is right for you and guide you through the process of building your own CD ladder.
Travis Sink is an Ohio native who flew south for the winter in 2014 and never went back. An avid consumer of all things from the tech and financial industries by day, he spends his evenings relaxing with his wife and dogs either reading, playing sports for local rec-leagues, or learning how not to burn dinner again.
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