The term 'Laddering' is included in the Banking edition of the Financial Dictionary. Get your copy on Amazon in Kindle, Paperback or Audio edition. Check for lowest price here...
Laddering is a strategy for managing overlapping CD maturities so as to not incur needless and potentially expensive early withdrawal penalties. Investors would employ such a strategy as this for a good reason. Consider that many savers will find that they covet the more substantial certificate of deposit rates offered on the longer term from three to five year (and even ten year) certificates. The problem is that they fear the uncertainty that comes with tying up their money for several years.
This is why investors would consider utilizing the effective certificate of deposit maturity management strategy of Laddering. The gist of this time tested and proven strategy revolves around investing in a range of different maturing CDs. Each single CD or group of CDs should have a variety of different lengths of terms. When each closest dated term certificate matures, the investors take the resulting proceeds and reinvest those in another CD that possesses the longest possible term.
The idea behind this is that some portion of the funds which the investor ties up in the certificates of deposit will nearly always be maturing. Should the investor require some portion of the funds then, he or she will be capable of accessing them without having to suffer early withdrawal penalties of from three to six months’ worth of interest payments as punishment for breaking the time deposit.
With any complicated investment concept, it always helps to look at a real world example. This clarifies the idea by putting it in tangible terms that are easier to picture and grasp. Consider this following example. Perhaps an investor John has $100,000 to save and invest. John might divide the money up into five even lots. This would amount to $20,000 per lot. He could then take each $20,000 and invest it in a variety of maturing CDs. The best strategy in this case would be to put $20,000 in a one year CD, another $20,000 in a two year maturing CD, a third $20,000 into a three year CD, a fourth $20,000 into a four year CD, and the final $20,000 in a five year long certificate of deposit.
When the first year elapsed, John would have his shortest dated, one year maturity CD pay out. He would then take that $20,000 plus interest and place it into another five year term length time deposit CD. On the second year, he would similarly reinvest his take from the two year maturity time deposit into yet another five year long maturity certificate of deposit. Each year, he would continue to have one time deposit mature, and he would take those funds and ladder them into another five year deposit.
By repeating the Laddering procedure, within five years John will own five different five year long certificates of deposit (with one maturing every single year). This would provide him with the coveted flexibility he needs to cash in a time deposit CD each year and never risk the grueling penalties of early withdrawal should he need the funds.
It is important to realize that choosing to invest funds in time deposit CDs like this will never be the fastest means of increasing money, even when utilizing a Laddering strategy. It is similarly extremely safe and comes with very little risk. The government guarantee of principle for up to $250,000 per CD means that the money will be returned by either the bank, the FDIC Federal Deposit Insurance Corporation or the NCUA National Credit Union Administration.
By employing the laddering strategy, investors can at least capture those CD rates which prove to be the highest possible on the market. Should interest rates rise, then every year the investors are able to upgrade to a CD based on the higher then-current interest rates. This is a dependable way to make decent returns on savings money without having to tie it up for more than a year at a time.