Banking - CD Laddering

[This post is written and copyrighted by FIRE Finance (http://firefinance.blogspot.com).]

Before we started investing in stocks, bonds and mutual funds, we used to park our money in checking and money market accounts. They are FDIC insured. However we hardly got any returns from our money stowed in the above accounts.

Then we figured that most of the cash which we may not need to touch for a while can be put in 1 year CDs (Certificate of Deposits). The interest rates were higher. We were happy for a while. Then the rates kept on going up and up. But our CD rates were fixed and we could not touch our money till maturity.

Had we purchased 3 or 6 month CDs we could have taken advantage of the rate hikes by renewing the CDs at higher rates. What if the interest rates went lower and lower ? In that case locking in a high rate for a longer term seems wise. How are we supposed to know which way the rates would go? It is sort of trying to predict the market.

Instead we came across the concept of CD laddering. It is a strategy of investing in CDs that takes advantage of the rising rates as well as dampens the blow of falling rates. One can purchase CDs with varying terms and keep renewing them at the longest term.

Let us take an example. Suppose we have $10,000 to invest. In first week of June, we can purchase 3, 6, 9 and 12 month CDs of $2,500 each. Then at the end of every 3 months one CD will mature. We shall reinvest that maturity amount for 12 months and continue doing so on each subsequent CD maturity. The following table illustrates this strategy.

	CD1	CD2	CD3	CD4	CD1	CD2	CD3	CD4
Jun
Sep
Dec 06
Mar
Jun
Sep
Dec 07
Mar

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