Laddering

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Laddering is an investment strategy that can usually be used for certificates of deposit (CDs) and bonds. CDs and bonds issued for longer periods generally pay higher interest rates or coupon rates than those issued for shorter periods. However, putting all your available funds into buying a single CD or bond that has a longer maturity date means you are tying up your money until the instrument matures. This could be a problem if you have a need for the cash sooner, or if interest rates increase during the period to maturity, which might leave you unable to take advantage of the higher rates. You could make an early withdrawal of the CD before its maturity, but you would typically incur a penalty. You could also sell the bond in the secondary market, but your bond would be relatively unattractive to buyers who could buy new bonds at the current higher interest rates, and so you might receive less than you paid for it. Laddering helps mitigate these problems. The strategy involved is that instead of buying one instrument, you buy several. These are scheduled to mature at different dates in the future. For example, you might buy four CDs set to mature at six months, one year, eighteen months, and two years. The two-year CD would generally give you the highest interest rate, and the six-month CD the lowest rate. You therefore get the benefit of the higher long-term rate for the two-year CD and the benefit of access to some money when the sixmonth CD matures. When that six-month CD does mature, you can then buy a two-year CD at an interest rate that is generally better than that paid by the expiring CD. You know that in another six months your one-year CD will mature, giving you the choice of re-investing that money in a two-year CD or using the cash if needed. The same principle will apply when the eighteen-month CD expires in a further six months. When the fourth CD matures after two years, by reinvesting the money in another two-year CD you will then have all four CDs invested at the higher two-year rate, but with the flexibility of having one of them expire every six months. Because the CDs mature in stages, or steps, the strategy is known as laddering, or "building a ladder" of CDs (or bonds). While laddering is generally accepted as an efficient and effective investing method for fixed-income instruments, the prevailing economic climate and outlook for the future should always be taken into account.