Fast Lane
CD laddering
Smart Business Cleveland | July 2004
Since 2000, we've seen tremendous changes in the equity markets. Because of these volatile swings, many investors continue to seek refuge in conservative investments such as certificates of deposit.
CDs are accounts that pay an investor a specified interest rate over a stated time period of anywhere from one month to five or more years. The longer the investment period, the higher the rate of return in interest. If the investor withdraws the money before the CD matures, an interest penalty is applied.
Because current CD interest rates are so low, some investors have opted to lock themselves into long-term CDs to maximize returns. However, if interest rates rise, an investor may miss out on increased income because he or she is locked into that long-term CD. And the investor is losing all liquidity by tying up the asset for an extended period of time.
One method to solving these issues is the CD Ladder approach. Instead of taking a lump sum of money and purchasing one CD with one maturity date, purchase multiple CDs with different dates of maturity. Each CD represents a "rung" on a ladder.
If you have $25,000 to invest, open five CDs with $5,000 in each one, as follows.
* One-year CD -- $5,000
* Two-year CD -- $5,000
* Three-year CD -- $5,000
* Four-year CD -- $5,000
* five-year CD -- $5,000
In this example, as each CD comes up for renewal, purchase a new five-year CD. This allows you to take advantage of changing interest rates maintain some liquidity in your CD portfolio.
The CD Ladder is an easy concept to employ, which over time leads to better returns and predictable cash flow. Source: Robert Coode Jr., Skoda, Minotti & Co., (440) 449-6800 or rdcoode@smcofinancial.com.
