What are the benefits of investing in a CD ladder?
There are several reasons why investing in a CD ladder is a more profitable strategy than investing in a regular CD.
One of the biggest downsides of investing in a CD is that the money remains inaccessible to you until the maturity date. For instance, if you invest in a two-year CD, you can the money (your initial investment along with the interest) only at the end of the second year.
If you try to cash it in earlier, you not only have to forego the interest earnings for the remainder of the term but also have to pay the penalty.
You could invest in a short-term CD, but the rate of interest offered is typically much lower compared to what you stand to earn from a long-term CD. This problem can be rectified by building a CD ladder.
When you build a CD ladder you can access a portion of your investment every year. You also earn a higher interest rate compared to what you can earn from a stand-alone CD, since you are investing in long-term CDs.
Let us assume that your one-year CD earns a 1.5% interest and the five-year CD earns a 2.5% interest. You build a CD ladder with five CDs (as illustrated in the previous section) and every time a CD matures, you can replace it with a five-year CD.
In the sixth year, you will have five CDs earning a 2.5% each. Since these CD is set to mature at one-year intervals, you can access a portion of your investment every year if you want to — without paying any penalties.