CD ladders allow you to benefit from the higher interest rates associated with longer-term investments, and they provide you with steady access to your money. Here are a few more reasons to consider this strategy.
Certificates of deposit (CD) ladders have been around for a long time, though they’ve been largely ignored by many investors because they have a lower interest rate than some other savings products.
But for younger investors, CD ladders can be a great way to plan and save for the future, because they offer liquidity, security, and the higher interest rates that come with longer-term investments.
First things first: What are CD ladders?
In financial terms—as opposed to circa 1990s musical terms—a CD is a certificate of deposit, a savings product with a fixed maturity date and fixed interest rate.
One of the problems with CDs, however, is that to get access to the highest interest rates, you typically have to lock your money in for extended periods of time. A one-year CD will offer a much lower interest rate than a five-year one.
And that’s where a CD ladder comes in.
This is an investment strategy that uses multiple CDs with staggered maturity dates. That way, you still get access to the higher rates provided by long-term CDs, without having to tie up all your money in a single fixed-term investment.
In other words, a CD ladder affords you higher interest rates than short-term investments, but it also means you don’t lose access to all your money. Because the CDs mature at different intervals, you regularly regain access to portions of your money as the individual rungs mature.
Getting the most bang for your buck: Investing when interest rates are high
There’s nothing to say that you can’t invest different amounts for each product. In fact, if the interest rates are at a higher-than-average percentage, you might be better off locking more substantial sums into the longer-term products.
You could optimize the your investments by investing larger sums for the more extended terms at the higher rates.
CD ladders offer many of the advantages that CDs do, but without some of the drawbacks
In the investment world, you usually have to choose between a reasonable interest rate and a safe investment. This is because higher-risk investments typically offer the possibility of the highest returns, whereas safe investments have a much lower—though guaranteed—ROI.
A CD ladder gives you the best of both worlds, because they have a higher interest rate than comparable investment products, but they’re also very safe. In fact, all CDs are insured by the government, meaning there’s no risk to your finances.
Furthermore, CD ladders also let you overcome one of the drawbacks of a traditional CD. With a regular CD, your money is locked in for a certain amount of time at a fixed rate. Unfortunately, this means that if interest rates increase, your investment isn’t eligible for the higher reward.
With a CD ladder, however, you can take advantage of rising interest rates because at every maturity interval, you can lock in your new ladder rung with the latest high rate.
Finally, as Goldman Sachs explains, although you start out the CD ladder with a few short-term investments, you end up with all higher-interest, longer-term products by the end of the first five years. At the same time, you still have investments maturing yearly, so you always have cash flow.
The ability to plan is a major advantage of CD ladders, which is hugely beneficial to young investors
Because CD ladders have fixed terms and interest rates, it makes it easy to plan for the future.
No matter how much the interest rates fluctuate over the course of your investment, you’ll still know exactly how much you’ll have when all your rungs come to maturity. This can make CD ladders an excellent way for younger investors to plan for significant future purchases.
For example, say you have $50,000 saved that you want to use in five years as a house down payment. You can invest in a CD ladder and calculate the exact amount that you’ll have in five years.
You can even plan maturity dates to correspond with your financial needs
There is a range of options when it comes to building a CD ladder. You can customize your investments based not only on your financial needs but also on when those needs will arise.
For example, say you have some money saved up for school, but won’t need it all in one lump sum. You can invest in a CD ladder and plan the maturity dates based on when your tuition payments will be due.
Similarly, if you have a plan for the future and know your significant milestones—such as when you want to buy a car or house, get married, start a family, etc.—then you can plan the maturity date of your rungs to accommodate any of those needs.
Not only will you make some extra money on the interest, but you’ll also have your money available exactly when you need it.
Drawbacks of using CD ladders to save for big purchases
There are a few downsides to the CD ladder that I have to mention. For one thing, the interest rates on certificates of deposit haven’t been stellar for a number of years.
There are two problems here: First of all, you might be able to earn a better ROI with a different product. Second, there’s always the risk that if you do lock money into a CD ladder, you might miss out if the interest rates do finally go up.
The related problem is that if you’re hoping to make a certain amount of money by a specific time thanks to interest payouts, you might not be able to accomplish that with a CD ladder, depending on the rates when you lock in.
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