Building a Ladder of CDs
Choosing the length of certificates of deposit (CD) is an important decision. The issues of liquidity and the future direction of interest rates can make the decision difficult. Longer maturity certificates usually provide the highest returns, but they also tie up your funds longer. Shorter maturities provide flexibility to take advantage of rising rates, but usually with lower returns. Ideally, you want the highest current return coupled with the ability to invest at higher rates if interest rates rose.
Creating a ladder of maturities is a way to create a portfolio of certificates that will put you in a position to earn good rates and invest at higher rates if interest rates rise. With this strategy, you divide your funds into pieces and buy equal amounts of different maturity certificates across a set timeframe.
When you do this, you ensure your average interest rate is the amount paid at the midpoint for that period. And each year, as a certificate matures, you can use the proceeds to buy another CD for that same overall timeframe. That way, as time goes by, more and more of your funds earn the highest rate, and you still have annual liquidity. If rates rise, you have access to your money to buy higher yielding certificates. If rates fall, you are still earning high rates on your existing positions.
No one can accurately predict the future of interest rates. Using this ladder of maturities strategy can help position you to benefit regardless of the direction of interest rate changes.