A CD or a certificate of deposit is a type of savings account that is normally insured by the FDIC or Federal Deposit Insurance Corporation. The main distinguishing factor between a high-interest or normal savings bank account and a CD is that the depositor complies to keep the money in the account for a set period of time without withdrawing any money from the CD. The end of the term is referred to as the maturity date of the CD.
A CD ladder refers to a plan of investment wherein the investor deposits money in several CDs with varying maturity dates. The aim of a CD ladder is to get better interest rates as compared to a normal savings account while ensuring flexible and regular access to the earnings and CD savings accounts.
Investing in a CD ladder allows depositors to use their saved money and spread it across different CDs with varying maturity dates. Thus, when the tenure of a specific CD ends, the investor can take out the money from it and use it or reinvest it in another CD with a term length that is higher than the maturity date of the current CD ladder. Thus, in this manner, you will add another rung to the current CD ladder thereby continuing the CD ladder investment.
The term lengths for CDs typically vary from 3 months, to 6 months, to 12 months, or to 5 years. There are also many other CDs with maturity terms of 24 months, 36 months, and 48 months. The interest earned on money invested in CDs proportionally increases with an increase in the duration of the term. In case money is withdrawn from a CD before the maturity date, then there may be a decrease in the overall interest earned on the investment in addition to an early withdrawal penalty charge.
With a CD the interest rate remains locked in for the length of the CD till the maturity date. Thus, even if the federal interest rates decrease it does not affect the interest rate of the CD. The money invested in the CD along with the associated interest rate continues to remain the same irrespective of what occurs with regards to the federal interest rates. There is also a reduced risk of liquidity in case investors need to withdraw funds during an emergency.
With reference to a CD ladder, each investor has the below listed 3 options every year:
- The investor can take out all the money in the CD and use it somewhere else.
- He/she can withdraw a part of the money, such as the interest earned on the CD, and use it somewhere else or reinvest in a new CD
- He/she can directly invested all the money, including the interest, into a new CD thereby adding a new rung to the CD ladder
It may be noted that banks may opt for a hard credit inquiry when you want to open a CD account. This can adversely affect your credit score.