Question: I know that BuyandHold doesn’t offer bank Certificates of Deposits (CDs), but you mentioned sometime ago that the affiliate company does. I would like to learn more about laddering. Just how does it work?

A BuyandHolder

Dear BuyandHolder,

Laddering is an interesting strategy – one that’s best for those who: (1) don’t want to track rates, (2) who don’t want to try to figure out when they are at their highest or lowest; and (3) have a chunk of money to invest in several CDs. Laddering, as you’ll see, does not work with only one or two CDs.

Keep in mind that with CDs, longer maturities offer better rates but they also expose you to the fact that interest rates may rise and your money will be locked into a certificate that’s then paying a rate lower than the going one.

Laddering helps alleviate this problem. It’s also a way of not putting all your eggs in one basket. Here’s a typical example.

Let’s say you have $10,000 to invest. You then divide your investment into five $2,000 segments and invest $2,000 in a one-year CD, $2,000 in a two-year CD, $2,000 in a three-year CD, $2,000 in a four-year CD and $2,000 in a five year CD. At the end of the first year, you take the first $2,000 CD and purchase a new five-year CD. When the second CD comes due, you again buy another new five-year CD. At the end of four years, all of your CDs have five year maturities. You have purchased the highest paying CD each year.

If you put all your money into one long-term CD, rather than laddering, then you must wait for the CD to mature (or pay a penalty) to retrieve your money. With a ladder you will have money coming due each year, and if necessary, you can break the ladder and take your money. An early withdrawal triggers an interest rate penalty for CDs.

When rates are very low as they are now, you might want to wait until they start to rise before beginning your ladder.

TIP: Whenever you do decide to build a ladder, first use the ladder calculator at:
www.bankrate.com/calculators/cd/cd-ladder-calculator.aspx. It will help you design the most appropriate ladder given the amount of money you have and the time frames you would like.

Laddering is not perfect but it’s a systematic way to save and you’ll always have a CD maturing fairly soon.