Q: I’d like to open a long-term savings account, so I’m reviewing options. What’s a CD ladder?
A: A CD ladder, called a certificate ladder at a credit union, is a savings tool that combines Share Certificate security with the flexibility of staggered maturity dates. Let’s look closer.
What is a certificate ladder?
Certificates of Deposit (CD) opened at a bank offer a fixed earnings rate over a set period and provide a reliable source of income. Their credit union counterparts, share certificates, are the same product – the terminology is the real difference. One drawback they both have is lacking flexibility due to having to commit funds to the full term. This is where certificate ladders come in: Instead of investing in one certificate with a fixed term, investors distribute their funds across multiple certificates, each with a maturity date to stagger them one year apart from each other. This creates a “ladder” of one certificate maturing each year.
What are the advantages of certificate ladders?
There are several advantages of certificate ladders:
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Increased flexibility. Staggered maturity dates give investors access to some of their funds each year instead of tying up all their savings for a single term.
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Liquidity. Investors can access a portion of their invested funds without paying penalties in the event of an unexpected financial need.
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Yield curve advantage. In general, the higher the risk for an investment, the larger the returns. By creating a ladder of certificates with varying maturity dates, investors can enjoy the potential benefits of both short- and long-term dividend rates.
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Lower reinvestment risk. Reinvestment risk refers to the concern that, when a fixed-income investment matures, the available rates may be lower than the original investment’s rate. With a ladder, investors can mitigate this risk by reinvesting a portion of their funds each year. If rates decline, only a fraction of the portfolio is affected.
What are the disadvantages of certificate ladders?
Certificate ladders are not a wise choice for everyone. First, each certificate within the ladder has a fixed term. This means early withdrawal penalties may apply if funds are accessed before the maturity date. Also, the rates offered on certificate ladders may not be as high as those on riskier investments, like stocks or bonds.
Use this guide to make an informed decision about investing in a certificate ladder.