certificates of deposit (CD)

What is CD?

A certificate of deposit is a money market instrument characterized by its set date of maturity and interest rate. A CD is often thought of as a low-risk investment, but you have to lock away your money for a period of time. There are two basic types of CDs: traditional and negotiable. Traditional bank CDs typically incur an early-withdrawal penalty, while negotiable CDs have secondary market liquidity with investors receiving more or less than the original amount depending on market conditions.  Looking at interest rates for certificates of deposit (CD), the longer your cash is in a CD, the more money the bank pays you in the form of high-interest rates and compounding interest (when the money earned by interest earns its own interest). The longer the term, usually, the greater potential for cash savings. But for that, we have to lock our money for long and we can’t use it. So, the solution is a CD ladder.

What is CD Ladder?

A CD ladder is an investment strategy where we invest our money in series of CDs with different maturity dates. So, instead of locking our money in one CD with long maturity date we can open 3 or 4 CDs with small-small amount with different maturity dates. For example, we could invest our money up equally to open a one-year CD, a two-year CD, a three-year CD, and a four-year CD at the same time to build a four- year CD ladder.

A CD ladder Example

So, let’s say that I have Rs 20,000 to invest. If I put that into a single 5-year CD, I might earn a better rate, but I also cannot take out my money before 5 years.

Instead of that I break that amount down into 4 stages (1st, 2nd, 3rd and 4th) of Rs 5,000 each, representing 4 different terms (1-, 2-, 3- and 4-year CDs), here’s what might happen if I build a CD ladder, As I reach each step, I have the option to cash out my CD or renew it again and move it to the top of my CD ladder for a later cash-out date. So, when we create a CD ladder, we are able to access part of our investment each year while the remaining CDs are actively making money. After each CD comes to term, we can keep adding on to our CD ladder even well into retirement.

Is CD ladder a good option for investment?

CDs are the safe investment options and their return is also guaranteed but we will sacrifice the possibility of better returns in an investment option with more risk and price volatility. So, a CD ladder strategy works for some people, it won’t work for everyone. It all comes down to how you feel most comfortable saving.