CD Laddering and Reverse Laddering
What Does Laddering CDs Involve
The concept is fairly simple. Instead of putting all of your eggs in one basket, you split your money up between separate Certificates of Deposit that are purchased at different times. The goal is to purchase longer dated Certificates, but still have a CD mature every year.
When to Ladder CDs
Laddering CDs is more popular when interest rates are going up. This is usually the case when inflation is a worry and the government tries to cool combat it with raising the interest rate. When the interest rate is in a down trend, longer term ladders can still make sense. For example, say you put $1,000 in a 3 year CD. If you wanted to build a ladder, then you would put in $1,000 in a 2 year CD at the same time. For a third "rung" on the ladder, you could put in $1,000 in a 1 year CD at the same time. Then, you would have a CD maturing every year if you rotated your maturing CDs. For example, after 1 year, that CD would be renewed as a 3 year CD and so would the rest as they matured.
When to Reverse Ladder CDs
Reverse laddering is a tool used by many when saving up for a particular item that will be purchased at a particular time. For instance, if you knew that you would be purchasing a home in 2 years, you would purchase CDs so that they all matured at around the same time as the home purchase. This is less dependent on the economic situation and more dependent on a particular personal goal.
Why CDs in the First Place
CDs are a low risk, low reward investment. I hesitate to say that it is a no risk, low reward investment because there is always risk in any investment. The FDIC guarantees up to their maximum amount, but who says the banking system will always be stable? Chances are the money is safe so many people decide to invest their money in CDs.
Danger Danger
There are Certificates of Deposit that are not standard and those cannot be considered low risk, low reward. Some pay interest that is indexed to some market such as the stock market, currency market, or commodoties market. These need to be thoroughly researched and you should consult a financial professional before deciding to purchase those types of CDs. There are tax considerations and opportunity cost considerations.
The concept is fairly simple. Instead of putting all of your eggs in one basket, you split your money up between separate Certificates of Deposit that are purchased at different times. The goal is to purchase longer dated Certificates, but still have a CD mature every year.
When to Ladder CDs
Laddering CDs is more popular when interest rates are going up. This is usually the case when inflation is a worry and the government tries to cool combat it with raising the interest rate. When the interest rate is in a down trend, longer term ladders can still make sense. For example, say you put $1,000 in a 3 year CD. If you wanted to build a ladder, then you would put in $1,000 in a 2 year CD at the same time. For a third "rung" on the ladder, you could put in $1,000 in a 1 year CD at the same time. Then, you would have a CD maturing every year if you rotated your maturing CDs. For example, after 1 year, that CD would be renewed as a 3 year CD and so would the rest as they matured.
When to Reverse Ladder CDs
Reverse laddering is a tool used by many when saving up for a particular item that will be purchased at a particular time. For instance, if you knew that you would be purchasing a home in 2 years, you would purchase CDs so that they all matured at around the same time as the home purchase. This is less dependent on the economic situation and more dependent on a particular personal goal.
Why CDs in the First Place
CDs are a low risk, low reward investment. I hesitate to say that it is a no risk, low reward investment because there is always risk in any investment. The FDIC guarantees up to their maximum amount, but who says the banking system will always be stable? Chances are the money is safe so many people decide to invest their money in CDs.
Danger Danger
There are Certificates of Deposit that are not standard and those cannot be considered low risk, low reward. Some pay interest that is indexed to some market such as the stock market, currency market, or commodoties market. These need to be thoroughly researched and you should consult a financial professional before deciding to purchase those types of CDs. There are tax considerations and opportunity cost considerations.
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