Definition: A 'CD Ladder' is a savings strategy where a saver or investor buys Certificates of Deposit (CDs) in increments over time. Similar to dollar-cost averaging with stocks and mutual funds, an investor, for example, will buy a fixed dollar amount on a monthly or quarterly basis.
How to Build a CD Ladder
CDs can be purchased at banks or credit unions or investors can search for the highest CD interest rates on Internet sites, such as Bankrate.com. It is important to note that CDs typically have minimum purchase amounts. Also, CDs have stated time periods (maturities) and the saver's money is tied up for the given period of time. If the saver withdraws money before the time period is up, they may be charged a fee.
Therefore, to invest with CDs, you need to have two things -- money and time. The CD laddering approach, however, reduces the concern over liquidity (quick access to cash). So the CD investor can save with CDs AND have access to cash by using the CD laddering approach.
A CD laddering strategy is just as it sounds: A saver "builds" a ladder of CDs one rung at a time buy purchasing CDs consistently and periodically over a planned period of time.
The timing and intervals of the ladder require a bit of planning. Keep in mind that For example, if the saver has $10,000 to save, they may consider buying a 1-year, $1,000 CD every month for 10 months. Beginning in one year from the first CD purchase, the saver will have one CD maturing each month for 10 more months. Therefore, cash is available every month when the investor or saver can decide to renew the CD (at hopefully a higher interest rate) or use the cash for some other need.
When to Use (and When Not to Use) CD Laddering
Investors and savers use CD laddering for two primary reasons: 1)they want access to cash if needed and/or 2) They expect interest rates to rise and they want to periodically buy into higher rate CDs as they continue ("climb up") the ladder.
Therefore the best time to use the CD ladder is when interest rates are low and are expected to rise in the near future. For example, a CD investor will not want to tie up all of their savings in one low-rate CD for too long. If interest rates are expected to rise the CD investor will be able to renew at higher rates as each individual CD in the 'ladder' matures.
Equal and opposite, if interest rates are high and expected to fall, a CD ladder may not be the best option for the CD investor. They may want to consider buying longer maturities, such as 3-year or 5-year CDs to "lock in" higher rates. In this high interest rate scenario, the CD investor who needs quick and easy access to cash (high liquidity) may want to continue CD laddering or they may use money market funds for liquid needs.
Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.
