A certificate of deposit or CD is a low-risk investment method that allows investors to profit through the accrual of interest. Essentially, a CD is an agreement made with a financial institution, most commonly a bank or credit union, wherein an investor deposits a fixed sum of money and agrees not to withdraw or otherwise alter the sum for a fixed amount of time. This time period can last anywhere from three months to five years. In exchange, the bank offers a higher than normal interest rate. A CD could be considered a loan that you give the bank with the understanding that the bank will repay the loan, plus interest, at the time of maturity (the financial term for the expiration date).
The biggest downside to investing in CDs is that the money is tied upon the fund for the agreed upon amount of time. Since long-term CDs have the highest interest rates and therefore the highest overall refit yield, they may seem like the best option. However, this also means that the funds in the CD will be inaccessible for a longer period of time. One common way of getting around this, while also maximizing the profitability of the CD, is to use what is called the ladder strategy.
Laddering is basically a way to avoid investing all of your money in a single CD and therefore making it inaccessible in the long-term while also making sure that you will ultimately receive the best return on your investment. Instead of investing all the money into a single long-term CD, the investor puts smaller amounts of money into several different CDs with different maturation periods. For example, an investor with $5,000 can deposit $1,000 into 5 CDs. The first CD lasts for 1-year, the second lasts for 2-years, and so on. Every time one CD matures, the investment is then rolled over into the next CD. At the end of the 5-years, the $5,000 investment is in the 5-year CD with the highest interest rate and therefore yield maximum profit.
Besides the higher profits, laddering also makes it possible to withdraw the funds, if necessary, without any penalty when each individual CD matures. Laddering is an important investment strategy to consider when investing in CDs.
