One of the most common strategies used when investing in a Certificate of Deposit (CD) is CD laddering. This technique allows savers to stagger the length of time their money is tied up. By choosing multiple Certificates of Deposit (CDs) with various maturity dates, you can put your savings to work for you without tying up all your savings at once. Read this expert advice on what CD laddering is and how to use it to maximize your savings returns.
- understanding what laddering is
- consider your needs
- use the same bank
- set a review date
- keep it simple
- focus on interest rates
- touch the money prematurely
- choose short maturities
- forget about them
- be afraid of asking your banker for help
Laddering allows you to take advantage of interest rate changes and have intermittent access to your savings. Instead of buying one CD, you buy several CD’s each with a different maturity. So one CD would mature in one year. The next in two years. Then three years. Then four years. This way you have four CDs, each maturing one year after the other. Every year you have the option of purchasing another CD to keep the ladder going or using the savings for a predetermined goal.
What do you use your savings account for? Emergency fund? Saving up for a new car? Big trip next year? Whatever the reason or reasons, you’ll want to take an inventory of them and then write down the dates you’ll need the money. CD laddering is great because it allows you to increase your savings return without tying up all of your savings. When you need the money should determine how many CDs you buy and how long the maturities should be. If you don’t know, then laddering with one CD maturing each year is the best place to start.
When you build a CD ladder, all the CDs should be with the same bank. I want you to think of CD laddering as an advanced version of a savings account. You ladder the CDs so that you will always have access to a portion of your savings just in case you need it. It’s much easier to remain organized and track your CDs if they are with one bank and tied to one savings account. You can easily manage them and you’ll always know exactly where your savings is. The last thing you want is to have an emergency and flip through bank account records to figure out which bank has the CD you need to liquidate to cover the emergency.
As busy as tax time is, April just might be the best time to review your CD ladder. You want to review your ladder at least once a year to see if there are any changes that need to be made as a result of new life developments. I suggest tax time because you're already thinking about your finances at that time of the year so it’s much easier to add reviewing your CD ladder to your to do list.
CD laddering is designed to be a simple solution to maximizing savings rates. Making it more complicated does not mean it’s going to work better for you. A simple ladder with a CD maturing every one to two years is where you should start. You don’t need multiple ladders with multiple maturities each year. One ladder and one CD maturity a year is all you need to get started.
When creating your ladder, your focus should be on time frames, future life events, and when you might need your savings. How much you are getting paid should not be part of your focus. CD laddering is an alternative to savings; not an investment strategy. The rates you’ll be getting are better than that of your standard savings account and you’ll be able to take advantage of the better long term rates when you purchase CDs with longer maturities for your ladder. You don’t want to change the maturity of a CD in your ladder just because you’ll get a better rate. What’s more important is that you time the maturities correctly so you’ll have the money when you need it.
Once you’ve purchased a CD, you need to plan on not touching that money until the CD matures. Taking money out of a CD early often involves paying fees significantly higher than the interest you’ve received. The laddering strategy allows you to take advantage of better rates because each year a CD matures and you can lock in the new better rate when you purchase another one to extend your ladder.
If you’re going to need your money in less than 6 months, a CD isn’t right for you. When laddering, it’s best to choose maturities that are one year, two years or even five years out. Any less than a year and you're going to have to be constantly purchasing a new CD every three to six months to keep your ladder going. It’s much better to have one time a year where you check your CDs, instead of having to check them every six months.
Depending upon how spaced out your CDs are, you are going to have to roll money from a matured CD into a new CD every one to two years. Even if rates aren’t as great, you need to keep the ladder going and put the money back to work in a new CD.
Still not sure you can do this? Think your situation is different? Your banker will be very familiar with the CD laddering strategy and will be happy to help you figure out how to best set up your ladder.
CD laddering is a powerful strategy when used correctly. It can be modified to work with any short-term savings time frame. It’s important to remember that CD’s are a way to save, not invest. CD laddering will allow your savings to work harder for you without completely sacrificing the ability to use them when you need them most.