Today, many investors are looking for safety. Certificates of deposit provide a guaranteed return of principal, plus a little extra gain. However, today’s CD rates have fallen dramatically since the Federal Reserve began slashing interest rates in the wake of the financial crisis.
How can investors get a better return on their savings? Many experts recommend laddering. This approach allows you to search for today’s best CD rates, while also saving a little cash so you can take advantage of higher rates in the future.
How does laddering work?
The length of the ladder is determined by you, the investor. It can be as short or as long as you choose. Here is an example of how a five-rung, five-year ladder can enable you to take advantage of the best CD rates available.
Let’s say that you have $25,000 to invest. You would begin by purchasing one $5,000 one-year CD (the first rung of your ladder). Then you would purchase one $5,000 two-year CD, and continue the process until you use your remaining $5,000 to purchase a five-year CD (the fifth and final rung). When your one-year CD comes due, or matures, you can reinvest that money into a new five-year CD since your first five-year CD now has only four years remaining.
What are the other benefits of laddering?
Rolling your money into a new five-year CD as each year’s CD matures can allow you to take advantage of the best CD rates available. In addition, it can eliminate much of the emotional decision-making that accompanies investing. It can also provide a steadier stream of income by reducing the wide swings — both high and low — that are part of interest rate cycles.
By automatically replacing your longest maturity, you will always be in a position to get the highest rates. Also, by using the ladder system, you will only be reinvesting some of your finances when returns are low. To find out more about CD laddering, see the Bankrate feature, “Laddering: How to build a CD ladder.”