CD Laddering

Laddering a Certificate of Deposit: CD Laddering is a investment strategy used when interest rates are rising, usually when the economy is strong and the Federal Reserve is raising interest rates to prevent the economy from over heating and fanning inflation. Though interest rates can rise during a slower economic environment, during “stagflation times” like we had in the 1970′s and we might have again.

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 when CD rates are rising is CD Laddering.

How CD Laddering Works

The strategy used in a CD Ladder is to evenly spread out the CD deposits over a period of several years, with the end result being the CD investor has all of his/her monies deposited in longer term CDs which pay a higher rate of return, but still has a CD mature every year, this way the investor benefits from investing in higher CD rates and has the option to re-invest in longer term CDs or to withdrawal the money.

Example of a CD Laddering Strategy

We will use a three year strategy with $30,000 for this example. The CD investor deposits $10,000 in a 3 year CD, $10,000 in a 2 year CD and $10,000 in a 1 year CD.

After year one, 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.