19 Jun What you need to know about CD laddering
A Certificate of Deposit (CD) is a special savings vehicle that offers distinct advantages over savings accounts. Although several different types of CDs exist, the most common option requires you to keep your funds in the CD for a certain amount of time, called a term. In exchange, you receive a set interest rate which is established before you buy the CD.
However, interest rates fluctuate on a regular basis, and to deal with the changes, some people use a strategy called CD laddering. Are you wondering how laddering works? Take a look at the essentials.
What Is Laddering?
As indicated above, CDs all have different terms. To ladder a group of CDs, you buy a number of CDs with different term lengths.
For example, imagine that you have $5,000. You could buy a single CD with a five-year term. However, because you’re interested in laddering, you buy five CDs worth $1000 each, and you select a different term for each CD. So, the first CD may mature after a year, the second after two years, and so on until the fifth CD matures in five years.
Why Do People Use Laddering?
By laddering the CDs as explained above, you avoid locking yourself into a single interest rate. To continue with the above example, imagine the 5-year CD has a 2% interest rate. When you put all your money into that CD, you can only receive that interest rate for five years.
In contrast, when you buy CDs with different maturity dates, you can take advantage of any other interest rates that appear during the five-year period.
Imagine that you buy five $1000 CDs with different terms as described above. They all have a 2% interest rate. When the first CD expires at the end of its one-year period, you contact the bank to buy a new CD, and at this point, you learn that you can buy a CD with a 3% interest rate.
As a result, you end up earning more money on that portion of your investment. Then, when the next CD expires, you can continue this process, and hopefully enjoy higher interest rates all the way up.
Does Laddering Come With Risks?
Any investment will come with risks. If your CD matures and interest rates have fallen, you may end up investing your funds into a CD with a lower interest rate than you had at the beginning. However, because you constantly have CDs maturing, you almost always have the opportunity to invest at different interest rates, and that helps to create balance.
That said, CDs are considered to be an extremely safe investment. When you invest in a CD, you know from the outset exactly how much you are going to earn, and you also know that you won’t lose money. In contrast, if you buy stocks, you accept the risk that the value could drop to nothing and you could lose your funds.
Is Laddering Advantageous?
Beyond allowing you to take advantage of different interest rates, laddering is also advantageous because it helps to preserve some liquidity. Typically, when you put funds into a CD, you can’t take out the money until the maturity date. If you take out money before the maturity date, you may face a penalty. However, with laddering you have CDs maturing regularly, and by extension, if you need cash, you can just keep the funds instead of reinvesting them.
Note that you can get CDs with no withdrawal penalties, but typically, you receive a slightly lower interest rate in exchange for that convenience.
To learn more about the advantages of investing in CDs, contact us today. At Unison Bank, we are committed to helping our clients reach their savings goals through CDs, money market accounts, savings accounts, and more.