A Certificate of Deposit (CD) ladder enables an investor a periodic return of funds to 1) minimize asset class opportunity cost, 2) protect capital form inflation, and 3) maximize investment yield from CD's. CD ladders do this by combining a staggered investment horizon with dollar cost averaging. In other words, the CD's are 'laddered' in the sense they mature at different times allowing the investor to recoup funds while still having money invested in 1 or more certificate of deposits. This article will discuss the advantages and disadvantages, provide an example and relevant illustrative CD ladder links and offer CD Ladder tips and techniques thereafter.
Advantages and disadvantages of Certificate of Deposit Ladders
A Certificate of Deposit Ladder is a relatively safe investment as Certificates of Deposit are guaranteed by the financial institutions that issue them. CD laddering can also provide a more reasonable cash flow due to the expiration of the invested dollars at multiple time periods. This way, if the need for funding does arise, cash could become available via the CD Ladder within 6 months or less depending on the CD time horizons used in the ladder. The advantages and disadvantages of Certificate of deposit laddering are listed below.
Advantages of CD Ladders:• May be FDIC or NCUSIF insured
• Improved access to funds
• Hedges against interest rate risk
• Reduces inflation risk
• Multiple time horizons available
• Safe investment/ low risk
Disadvantages of CD Ladders:
• Earnings penalty imposed for early withdrawal
• Opportunity cost may not be averted
• Yield may non-profitable
• Interest rate may be low
• May provide low return after adjusted for inflation
Example Certificate of Deposit Ladder
As a CD ladder is created and followed through with, a rising value is invested with each new year and/or CD expiration. If the interest rates are higher or lower in sub-sequent years, the benefit of dollar cost averaging either softens the decline in interest rates or improves the overall average of the long term Return on Investment (ROI). The following link illustrates the benefits of dollar cost averaging CD's through laddering.
Year 1: 6 month at 2.4%, 1 year at 3%, 2 year at 4% and 5 year at 5% CD's invested in with equal denominations of $1000.00 USD.
• Net investment: $4000.00
• Net yield pre-reinvestment: $4372.00 (compounded annually)
Year 2: 6 month and 1 year mature and are reinvested in 6 month at 2.8% and 2 year at 3.2% CD's with the same denomination plus interest ex. $1000.00 + $30=$1030.00 for the 1 year and $1000+$12=$1012.00 for the 6 month CD
• Net investment: $4000.00
• Net yield post re-investment: $4452.00
Certificate of Deposit Ladder tips, tools and techniques:
Certificate of Deposit Laddering can be a useful tool in an individual investment portfolio, family trust or other financial strategy. Prior to setting up a Certificate of Deposit ladder, taking the time to understand, compare and familiarize with the product(s) can be beneficial to being properly aware and in the investment decision. The following linked to Federal Deposit Insurance Corporation (FDIC) website, and Securities and Exchange Commission (SEC) website provide helpful information on investing in Certificates of Deposit. Additionally, the tips below offer information on investing in CD ladders that may be useful in preparing for and planning a Certificate of Deposit Ladder.
1. SEC CD Information
2. FDIC CD information
3. Bankrate.com CD Ladder guide:
• CD Ladder Calculator: A CD ladder calculator can help you plan your investment objectives with laddered CD's.
• International CD Ladders: Overseas CD rates can be quite good. Laddering these CD's may be financially advantageous.
• Forecast interest rates: Interest rates change based on economic conditions. Forecasting these changes in advance can help you plan your CD ladder time horizons accordingly.
• Assess financial need: If the money invested in the CD ladder will be needed before the CDs expire, it may not be a good idea to invest so much in the ladder to avoid financial penalty.
• Create a model: A model or CD ladder chart like those linked to in this article can help you determine whether or not your yield will 1) be profitable, 2) laddered correctly and 3) average yield.
• Research issuers: A financial solvent financial institution may not only be better able to honor higher interest rates, but may also have a lower risk of financial insolvency.
• Compare interest rates and terms: Since rates vary, knowing which financial institutions offer which rates can help in the selection of CDs.
• Utilize ladder friendly financial institutions: For better CD ladder management, some financial institutions may offer special tools and banking services that allow investors to ladder their CD investments more efficiently through automatic reinvestment or online CD ladder management.
In summary, Certificate of Deposit laddering is an investment method that 1) preserves capital value, 2) improves inflation protected cash flow and 3) makes use of dollar cost averaging to better manage the invested funds. CD laddering is a safe investment that can be used alone or within a medley of investment techniques and strategy within an individual or household financial portfolio. The benefits of laddering outweigh the disadvantages if the investor is not expecting a high rate of return and is using the ladder to balance investments under the Federal Deposit Insurance limit.
Certificate of Deposit Laddering can be a useful tool in an individual investment portfolio, family trust or other financial strategy. Prior to setting up a Certificate of Deposit ladder, taking the time to understand, compare and familiarize with the product(s) can be beneficial to being properly aware and in the investment decision. The following linked to Federal Deposit Insurance Corporation (FDIC) website, and Securities and Exchange Commission (SEC) website provide helpful information on investing in Certificates of Deposit. Additionally, the tips below offer information on investing in CD ladders that may be useful in preparing for and planning a Certificate of Deposit Ladder.
1. SEC CD Information
2. FDIC CD information
3. Bankrate.com CD Ladder guide:
• CD Ladder Calculator: A CD ladder calculator can help you plan your investment objectives with laddered CD's.
• International CD Ladders: Overseas CD rates can be quite good. Laddering these CD's may be financially advantageous.
• Forecast interest rates: Interest rates change based on economic conditions. Forecasting these changes in advance can help you plan your CD ladder time horizons accordingly.
• Assess financial need: If the money invested in the CD ladder will be needed before the CDs expire, it may not be a good idea to invest so much in the ladder to avoid financial penalty.
• Create a model: A model or CD ladder chart like those linked to in this article can help you determine whether or not your yield will 1) be profitable, 2) laddered correctly and 3) average yield.
• Research issuers: A financial solvent financial institution may not only be better able to honor higher interest rates, but may also have a lower risk of financial insolvency.
• Compare interest rates and terms: Since rates vary, knowing which financial institutions offer which rates can help in the selection of CDs.
• Utilize ladder friendly financial institutions: For better CD ladder management, some financial institutions may offer special tools and banking services that allow investors to ladder their CD investments more efficiently through automatic reinvestment or online CD ladder management.
In summary, Certificate of Deposit laddering is an investment method that 1) preserves capital value, 2) improves inflation protected cash flow and 3) makes use of dollar cost averaging to better manage the invested funds. CD laddering is a safe investment that can be used alone or within a medley of investment techniques and strategy within an individual or household financial portfolio. The benefits of laddering outweigh the disadvantages if the investor is not expecting a high rate of return and is using the ladder to balance investments under the Federal Deposit Insurance limit.
Sources:
1. http://www.bankrate.com
2. http://www.cdladders.com
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