What is a Certificate Ladder?
Posted July 14, 2023
Q: I’d like to open a long-term savings account, and I’m reviewing my options. I’ve heard about something called a certificate ladder; is it a good choice?
A: A certificate ladder is a savings tool that combines the security of certificates with the flexibility of staggered maturity dates. Let’s take a closer look at certificate ladders and why this may be an excellent choice for your funds.
What Is a Certificate Ladder?
Certificate accounts have been a longtime, popular investment banking tool for individuals seeking a safe and stable place for their funds. They offer a fixed earnings rate over a specified period (term), and provide a reliable source of income. However, traditional certificates often lack flexibility since investors must commit their funds for the entire term. This is where certificate ladders come in.
Certificate ladders operate on a simple principle: instead of investing in a single certificate with a fixed term, savers distribute their funds across multiple certificate accounts with staggered maturity dates. For example, instead of investing $10,000 in a single 5-year certificate, a member may choose to allocate $2,000 to five different certificates, each with a maturity date of one year apart. This strategy creates a “ladder” of certificates, with one maturing each year.
What Are the Advantages of Certificate Ladders?
There are several significant advantages of certificate ladders:
- Increased flexibility. Staggered maturity dates give investors access to some of their funds each year instead of tying up all their savings for a single term.
- Liquidity. Investors can access a portion of their invested funds without paying penalties in the event of an unexpected financial need.
- Yield curve advantage. In general, the higher the risk for an investment, the larger the returns. By creating a ladder of certificates with varying maturity dates, investors can enjoy the potential benefits of both short- and long-term dividend rates.
- Lower reinvestment risk. Reinvestment risk refers to the concern that, when a fixed-income investment matures, the available rates may be lower than the original investment’s rate. With a ladder, investors can mitigate this risk by reinvesting a portion of their funds each year. If rates decline, only a fraction of the portfolio is affected.
What Are the Disadvantages of a Certificate Ladder?
Despite its many advantages, certificate ladders are not a suitable choice for all investors. First, each certificate within the ladder has a fixed term. This means early withdrawal penalties may still apply if funds are accessed before a certificate’s maturity date. Additionally, the rates offered on certificate ladders may not be as high as those on riskier investments, like stocks or bonds. As a result, individuals with a higher risk tolerance, as well as those seeking significant growth, may prefer other investment options.
Interested in learning more about certificate ladders and how they might work for you? Speak to a Member Services Representative in one of our local branches, or give our Member Service Center a call at 831.479.6000 or toll-free at 888.4BAYFED, option 3!
Categories: FinancialAdvice
