Laddering is a method of investing that helps you earn some interest now while reducing the risk of missing higher rates later.
Banks reward savers for choosing income investments with longer maturities, that is, for locking up their cash for longer periods, even multiple years.
But your money could end up stuck in a lower-rate investment during a period when interest rates rise. A ladder allows you to invest today and still get those higher rates down the road.
Laddering is found primarily in fixed-income investments that have a defined maturity date. This could be individual bonds, or even more commonly, certificates of deposit (CDs).
Picture a ladder. Let’s say there are four rungs on the ladder. As an investor, I have $100,000 that I want to keep relatively secure.
I could certainly take the $100,000 and place it into a longer term investment and earn a bit more interest.
However, I’m really concerned that interest rates may be on the rise, and I don’t want my money “locked up” at a lower interest rate. This is where laddering comes into play.
So I’ll separate my $100,000 out into five equal piles. The first pile I’ll set on the floor below the ladder.
This will represent my liquid, regular passbook savings account. I’m not going to earn a lot of interest on this money, but it will be available for me anytime I want it.
The next $20,000 I will put into a 90-day CD earning just a bit more of an interest rate. The third I put into a six-month CD earning more than the 90-day CD.
I’ll follow that with $20,000 in a nine-month CD, and finally a 1-year CD with the last $20,000. It earns the highest interest rate.
Every 90 days I have a CD coming due. If I’ve spent money from the floor pile, I replace it with money from the 90-day CD.
If I haven’t, I take the money from the floor and use that to buy a new 1-year CD. In the meantime, the original 1 year CD now has nine months left, the nine-month now has six, and so on.
If interest rates increase, I get to purchase that new, 1-year CD at the higher rates.
The overall idea is to always have predictable, periodic liquidity that gives me a chance at specific intervals to reinvest at higher rates or simply take out money.
You could also do this with individual bonds, with annuities with fixed maturity dates or, in some cases, various types of investments, including cash, fixed income, value stocks or growth stocks.
Nevertheless, the most common argument for laddering involves a fixed-income investment with a predictable, set maturity date.
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