How CD Laddering Works

Certificate of Deposit laddering (CD laddering) is strategy used to invest in certificates of deposit when CD interest rates are rising. CD rates rise when the economy is strong and the FOMC is raising interest rates to contain inflation. We will probably be in that exact scenario in the coming year.

The idea behind CD laddering is to have your investment in longer term certificates of deposit earning a higher CD interest rate than short term CDs earn. The longer the certificate of deposit term, the higher the interest rate or interest yield usually is, unless the yield curve is inverted.




Longer CD terms also may result in a loss of investment opportunity to lock in higher interest rates during a rising economy.  A common investment strategy to get around this is by laddering your CD investments.

When you setup a certificate of deposit ladder you evenly spread out the bank CD deposits over a period of several years, in the end you have all your deposits in longer term CDs. You earn a higher CD rate but still have a CD mature every so often. 

CD Laddering Example


We will use a three year strategy with $30,000 in this example. The CD depositor invests $10,000 in a 3 year CD, $10,000 in a 2 year CD and $10,000 in a 1 year CD. After the first year, the 1 year $10,000 CD matures, the CD investor then invests the money in a 3 year CD. After year two, the 2 year $10,000 CD matures, the CD investor invests in another 3 year CD.

After two years all the monies are invested in 3 year CDs at a higher interest rate, again, this only works  in a rising interest rate economic environment. The coming year will certainly bring higher CD rates so start planning your certificate of deposit ladder now.
 
Author: Brian McKay
December 25th, 2009
Posted in: CD Rates