HOW TO BUILD A CERTIFICATE LADDER


If you’re looking to earn the highest possible yield on your investments without sacrificing the safety of government backed insurance, certificates of deposits or share certificates are one way to go. By using a laddering approach with your certificate purchases, you can take things up a notch, gaining even more from this already solid investment.

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WHAT IS A CD LADDER?

Certificates typically offer higher interest rates than regular savings accounts in return for locking in your money for a set time period. The longer that maturity period is, the higher your earnings. However, if you put all your money in one long-term certificate and interest rates rise before its maturity date arrives, you’ll miss out on the chance to take advantage of those higher rates. Also, if an emergency comes up, you won’t be able to access that cash without withdrawing the entire amount — and getting hit with penalties on your earnings.

Laddering is the perfect way to get around this dilemma. Rather than buying one large certificate, this strategy involves purchasing multiple certificates with staggered maturity dates. That way, a portion of your cash is freed up each year for you to reinvest in another certificate at current rates or use for other purposes.

A TRADITIONAL CERTIFICATE LADDERING MODEL

A classic certificate ladder has five “rungs.” Each of these rungs represents a certificate of equal value, and their terms are staggered so that one certificate matures every year. For five years, for example, you could invest $5,000 this way:

  • $1,000 in a 12-month certificate
  • $1,000 in a 24-month certificate
  • $1,000 in a 36-month certificate
  • $1,000 in a 48-month certificate
  • $1,000 in a 60-month certificate

When the 12-month certificate matures, you can then use that cash to purchase a new 60-month certificate that will mature in year six, and continue this way so you get both the high returns that the longest-term certificates offer and the flexibility of having one-fifth of your investment freed up each year.

OTHER LADDERING APPROACHES

Laddering doesn’t have to be one size fits all. Those who can’t tie up money for a whole year might do well with a four-rung ladder consisting of a three-month, six-month, nine-month and 12-month certificate so that cash is freed up every three months. Or if you may need cash more frequently, build your ladder so that one certificate matures each month.

Another thing to consider is changing economic projections. When times are uncertain, a certificate ladder with equal rungs is the safest overall plan. However, if interest rates are clearly rising, you might want to invest a larger portion of your ladder fund in short-term CDs to take advantage of better offers as they become available. When interest rates are falling, it pays to invest as much as possible in long-term certificates, since you may not have an opportunity to lock in such good rates again for a long time.

CERTIFICATE LADDER BENEFITS

Whichever approach you choose, certificate laddering offers a number of advantages over purchasing a single certificate:

  • Higher income plus liquidity: Once your first certificate matures, you’ll enjoy long-term certificate rates without giving up frequent access to your cash.
  • Flexibility: You’ll be able to adjust your ladder to changing economic conditions and your individual financial situation.
  • Peace of mind: Whatever happens, you’ve got it covered. When rates drop, you’ve already locked in your return. And when rates rise, you’ll have available cash to invest regularly.

Most financial experts agree that interest rates should be on the rise fairly soon, so it might be wise to build a shorter-term certificate ladder to keep your options open.

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