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Climb to new heights with a Certificate ladder

September 23, 2016

By Thomas Muellner

After you’ve done the hard work of creating a strong financial foundation – setting up a retirement account, establishing an emergency fund, purchasing a home – you may be wondering what to do next with your money.

Are stocks best? What about real estate or mutual funds? 

Given the relatively low yields currently offered through most simple savings accounts, it’s clear that there are better options. But knowing where to turn can be a challenge. Even with discretionary income to put toward savings, it’s easy to be skeptical about whether playing the market is really worth the risk. 

One way savers can benefit from accrued interest while minimizing risk and maintaining a relatively high degree of liquidity is through a clever investment practice known as CD laddering. It involves using traditional Savings Certificates as a means to build wealth over time. 

It may be just the right fit if you’re looking for a way to grow your net worth while always keeping an extra cushion in reserve for financial emergencies. 

Savings Certificate basics 

Before setting up a Certificate ladder, it’s essential to have a basic understanding of how Certificates work.

In a nutshell, a CD (short for certificate of deposit) is a type of savings account that pays a set interest rate when a fixed amount of money is invested over a specific period of time. Savers agree to keep their funds invested in a certificate for the full duration of its term, and in return, they’re guaranteed to receive interest at a specific rate for the duration of the term, even if overall interest rates trend down during that time. 

It’s common for certificate terms to last a minimum of 6 or 12 months, but they can last for up to five years or more. In general, the longer you agree to invest your funds, the higher the interest rate you’re guaranteed to receive at the end of the certificate’s term.  

Keep in mind that Certificates are a highly secure investment because they’re insured up to $250,000 by the National Credit Union Administration (credit unions) or FDIC (banks).

How CD ladders work

CD laddering works by taking one lump sum and investing it in multiple certificates – some short-term, some medium-term and some long-term – with staggered maturation dates, typically at equal intervals. 

When the shortest-term certificate matures, you reinvest the funds from that CD into a new CD that matches the length of the longest-term CD from the set of CDs you initially opened. In doing so, you get the benefit of improved interest rates while maintaining access to funds, as there’s consistently a certificate that’s approaching full term.

What it looks like in practice

Pretend you have $20,000 stashed away in a simple savings account. You divide that cash into five equal portions and open certificates in 12-month intervals. In other words, you open five $4,000 certificates set to mature in 12, 24, 36, 48 and 60 months, respectively.

  • When your first certificate matures at the 12-month mark, you roll it over into a new five-year CD. Why five years? Because when you started the CD ladder process, your longest certificate term was 60 months. 
  • When the 24-month CD matures, you buy another five-year note. 
  • After the 36-month CD matures, you do the same, and so on. 

After five years have passed, you’ll have five 60-month CDs, each generating a significantly higher interest rate. The beauty is that because all are set to mature at the same 12-month interval, you’ll never be more than 12 months away from withdrawing funds.

Keeping reserves for emergencies

While certificate ladders provide flexibility, they’re not the same as cash. Because of this, capable savers should strive to have at least two months of living expenses tucked away in a simple savings account before they commit a substantial portion of their resources to a CD ladder. 

This will not only keep you protected in the event of an emergency, but will help you avoid both the headache and lost interest of withdrawing a certificate prior to its maturation date. 

It’s okay to get creative

Just because most CD ladders are set up with round numbers at easy-to-remember intervals doesn’t mean you need to stick to that script. Talk with your credit union or bank about the certificate options they offer and consider your own unique financial situation before getting started.

By adjusting the dollar value of each certificate or selecting a variety of different maturation intervals, you may even find that you’re more comfortable contributing additional funds over time. As long as you commit to the plan, you can be sure you’re always one rung away from cashing in a handsome return on investment.