Ladder a Certificate of Deposit

2019/08/22

Laddering is the process of buying the deposit certificates at different stages of maturity. With this, the funds invested by the investor does not become due at one time and have different maturity timings. You would be able to understand this with an example.

Suppose you have decided to deposit $10,000 in the deposit certificates with a local bank. Upon contacting the bank, you get the information  that the per annum interest rate of deposit certificates are based on the number of years you will buy the deposit for and it increases with the number of year.

So let’s say, the annual interest rate is 2% for one year, 2.1% for two years, 2.2% for two years, 2.3% for four years and 2.4% for five years. Spontaneously, you would want to invest for five years to get the maximum rate of interest which is 2.4%. However, on second thought and knowledge of laddering would encourage you to take the deposit certificate in a combination.

Market rate keeps on fluctuating and if the market rate increases to 3%, then you would not be able to take advantage of this market move and would incur the opportunity cost. Investing in the deposit certificates maturing at different time is a good idea to avoid this. You have to divide your money and then invest.

You can invest $2,000 in every type of deposit certificate. This way your $2,000 would mature every year and you can reinvest them by scanning the market and according to the best available interest rates.  This would give you the opportunity to reinvest every year and you would end up earning much more profit than by investing your $10,000 in the five year deposit certificate.

This is known as laddering and it has the huge potential to return immense profits. This also gives a cushion to the investor that due to unseen circumstances, if the investor requires the money, an increasing portion of it would be available every year.

The only limitation of laddering is that sometimes market is at peak and at that time, its always better to invest money for long term at the prevailing interest rate. For this, the investor need to study the market and should be able to decide the move of the market.

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