Certificates of deposit offer a unique balance of risk and reward that can form an important part of an investment strategy. Let's look at what makes CDs an effective choice for many people, how to use them following the ladder strategy and why this approach is especially popular.
CDs are a form of financial product known as a time deposit, which provide an established return after a similarly defined period of time. An individual deposits the desired amount of money, above the minimum set by the financial institution, and then waits for the CD to mature. Once the CD reaches the previously established maturation date, the person depositing the money can then withdraw both the principal and the earned interest.
CDs are seen as uniquely valuable because they offer an effective mix of growth and security. As a form of deposit, the CD is protected by the Federal Deposit Insurance Corporation. That means the principal is returned, even in an absolute worst-case scenario. That's not the only way a CD offers a guarantee, however. The interest rate is clearly available and set before any money is invested, meaning it's a simple matter to calculate the return of the deposit and determine if the investment is a good individual choice.
The rates offered with CDs depend on a number of factors. Interest rates set by the Federal Reserve impact the return on CDs, as do many other considerations. Additionally, individual financial institutions will offer different rates. You can see the current terms and rates TAB Bank has to offer here. As of February 1, 2019, rates ranged from 2.45 annual percentage yield for a six-month CD with a $1,000 minimum deposit, to 3.20 APY for a 60-month CD, also with a $1,000 deposit.
Balancing the length of the CD - the amount of time that the money must remain deposited - and the higher interest rates provided by longer deposits is an important consideration for anyone who wants to use them as part of a long-term investment strategy. Let's look at how the CD ladder investment strategy can help create an effective compromise between these two considerations.
Enjoying certificate of deposit interest rates while balancing the need to potentially access the funds may steer you toward using CDs with shorter terms. You can reduce the amount of time you have to wait to enjoy free access to the principal and interest by investing in several CDs of varying terms at once, a process called a ladder. Instead of having all of the money intended for CDs tied up in a single instrument, people who use this strategy enjoy more flexibility and access while also having more opportunities to reinvest their earnings into additional CDs or to use the money for a variety of other purposes.
Investor Junkie suggested two strategies for building a CD ladder. The first is very straightforward: Take the total you have to deposit and split it up into equal, smaller amounts that can be put into CDs, then make those deposits on a regular schedule. You simply have to determine how frequently you want the CDs to mature (every three months? every six months?) and how much money you want to have available at each time interval.
The second strategy is to take the total amount you want to deposit and open several CDs with different terms on the same day. You can focus on six-, nine- and 12-month CDs or spread the funds out over a longer period of time. No matter which approach you choose, you won't have to wait for all of the money deposited to become available at once, and you can adjust your investment strategy at each interval to match your personal needs, shifts in the economy and other important considerations.
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