One of the most fundamental ideas in investing is that of the “opportunity cost.” You can invest your money in only one thing, and if you use if for that only one thing, you lose out on the opportunity to use that money for anything else in the world. Those who are investing in certificate of deposits know this better than anyone. When you opt for longer term certificates of deposit, you get a better interest rate on your money, but you also possibly lose out if the prevailing interest rates in the economy were to increase. Most savvy investors who use certificate of deposits use what they call a ladder to mitigate unstable interest rates.
With a CD Ladder, the investor will distribute the money over a period of several years with the goal of having one’s money deposited at the longest term. This way part of the money matures annually, and when that money comes back in, he or she can reinvest it over a long period of time. This way the depositor reaps the benefits of the longest term interest rates while still having the options to re-invest the money, or withdraw it in short term intervals.
Let’s look at an example. Let’s say we were an investor who had $3,000 to invest in Certificate of Deposits, and wanted to do a three year ladder. We would put $1,000 in a 3 year CD, a 2 year CD, and a 1 year CD. From that point on we would re-invest the money at a three year term. After three years of this process, the investor would have all of the money deposited back at the three year rate
More often than not, the responsibility of maintaining this ladder falls on the investor, rather than the bank. This can be advantageous for banks with competing interest rates, but it can often be a time consuming proposition. One online bank decided to change this. ING Direct has created a system in which you can create your own ladder with your online savings account. You can open CDs with varying terms very easily through their website, and then have that money reinvested as you please. They simplify the process and make it much easier. This way you can have some of your money available to you each month, and you get much better rates than any savings account you might see. It’s definitely a worthwhile position if you are interested in creating a CD ladder. Currently they earn a 5.1 percent interest rate which is very competitive in the open market.