Benefits of creating a CD ladder
A CD or certificate of deposit is offered by financial institutions, banks, and credit unions as well. Although it is similar to a savings account, there are a few differences. Here, the individual would be depositing a certain sum of money for a certain period of time. This helps the depositor earn interest on that amount. These are essentially time deposits and the money will have to remain for that predetermined time period, or the term of the CD. The term may vary from six months to five years. The CD will mature only after the end of the time period.
A CD ladder is a technique that is used in order to avail maximum benefits out of investing in a CD. With the help of this technique the depositor can earn the highest interest rates and also ensure that the entire money is not blocked for a longer period of time. Normally, the investor will open a CD for a period of three to five years. However, this could prove to be disadvantageous for the investor if there is a rise in interest rates. In order to take advantage of the rise in interest rates, the investor uses this technique called CD laddering. So, instead of putting all the eggs in one basket, the investor will divide the principal amount and open even three or four CDs. The investor may open one CD for one year, the second one for two years, and so on and so forth. Once the first CD reaches the date of maturity, the money can be withdrawn and reinvested in another CD.
There are a number of benefits in creating a CD ladder. The money is available each year and in case the investor wishes to utilize the money for any personal requirement, they will not face a problem as the entire amount will not be locked for a long period of time. A portion of the investment will always be available every year. Since CDs are relatively risk free, this is the most preferred mode of investment.
Banks generally pay higher interest rates on CDs because they are aware that the money will be in their control for a long period of time.So, this is advantageous for the investor as well as the financial institutions and banks. The interest rates offered on CDs are termed as annual percentage yield (APY). The investor may receive the interest on a periodic basis or it may be allowed to accrue for the entire term. The interest earned may be sent in the form of a check or it may be done through an electronic deposit. The investor can earn compound interest if it is allowed to accrue and in such cases the interest that is earned is added to the certificate of deposit.
Starting a CD ladder is extremely simple and beneficial to the investor in more ways than one. Hence, this is hugely popular among investors as it offers a lot of financial freedom. This way the investor will always have money for other investments as well.
