CDs, or certificates of deposit, are a type of savings account offered by banks and credit unions. They typically offer higher interest rates than traditional savings accounts in exchange for a commitment to leave the money untouched for a set period. A CD ladder is a strategy for investing in CDs that involves dividing your money evenly among several CDs with different maturity dates. This allows you to take advantage of higher interest rates on longer-term CDs while still having access to some of your money regularly.
But did you know there are different types of CD ladders you can invest in? Today, we’ll be comparing brokered CD ladders vs. bank CD ladders to help you choose the right CD ladder strategy.
Benefits of a CD Ladder
There are many benefits to a CD ladder.
First, it allows for higher yields compared to traditional savings accounts or shorter-term CDs. By spreading out your entire investment over multiple CDs with varying maturity dates, you can take advantage of higher interest rates over time.
Secondly, you will always maintain near-term access to cash. Since the CDs are staggered with different maturity dates, some will reach maturity sooner than others. Once the CD matures, you’ll have access to this cash without penalty.
Finally, a CD ladder can also help investors deal with rising interest rates. As rates increase, the investor can reinvest maturing CDs into new, higher-yielding CDs. This allows them to take advantage of the higher rates while still having access to cash in the near term.
However, a CD ladder might not be the best option in a declining rate environment. In this scenario, holding one long-term CD might provide a better return than constantly reinvesting in shorter-term CDs with decreasing interest rates. This is a tradeoff that investors must consider when deciding whether to use a CD ladder or not, as no one can accurately predict the direction of interest rates.
Here’s an example of a CD ladder with $5,000 staggered across 5 different maturities.
- Invest $1,000 in a 6-month CD with a 1.5% APY.
- Invest another $1,000 in a 12-month CD with a 2.25% APY.
- Invest another $1,000 in an 18-month CD with a 2.5% APY.
- Invest another $1,000 in a 24-month CD with a 2.75% APY.
- Invest another $1,000 in a 36-month CD with a 3% APY.
When the first 6-month CD matures, you can reinvest it in a new 36-month CD. If you continue this pattern with every CD as it matures, you’ll always have access to your investments as cash every 6 months with higher returns on the longer-term CDs.
A Quick Recap on Brokered CDs and Bank CDs
Bank CDs (Certificate of Deposit) are a type of savings account offered by banks where the depositor agrees to keep their money in the account for a set period of time, typically ranging from a few months to several years. In exchange, the bank pays the depositor a fixed interest rate that is typically higher than what is offered for a standard savings account.
Brokered CDs similar, are often compared to bank CDs in that they offer a fixed interest rate for a set period. However, brokered CDs are bought directly from a brokerage rather than directly through a bank. This means that the investor has a much wider selection of CDs to choose from multiple banks. Almost always, the same CD sold on a brokerage will pay higher interest rates than the CD being issued directly from the bank.
Comparing Brokered CD Ladders vs. Bank CD Ladders
With a brokered CD ladder, you can have more variety in buying multiple CDs based on your cash needs. Brokered CDs also offer the opportunity to create a more customized CD ladder. A brokered CD ladder benefits from brokered CDs having more maturities, higher yields for the same maturity than traditional CDs, and many more CD options to choose from than issuing banks.
For instance, you can choose CDs from different issuing banks. On the other hand, bank CD ladders are typically more straightforward to manage, making them a good option for investors who prefer a more hands-off approach.
Pros and Cons of a Brokered CD Ladder
Pros of a Brokered CD Ladder
A brokered CD ladder offers several advantages.
First, it provides an investor with short-term access to cash, which can be a significant benefit for investors who rely on their investments for income. An investor can also decide to sell a brokered CD on the secondary market in the event of an emergency, something you cannot do with a bank CD.
Second, compared to a bank CD ladder, a brokered CD ladder gives you more flexibility to benefit from high rates through exposure to higher yields on longer-term brokered CDs. This can potentially lead to greater returns on your investment.
Third, through a brokered CD ladder, you can have multiple FDIC-insured CDs. This is different from a bank CD ladder where $250,000 is protected. Each CD in a brokered ladder is individually insured, providing an extra layer of insurance coverage.
Finally, another advantage of brokered CD ladders is that they can provide a higher level of diversification compared to bank CD ladders. Since brokered CDs are offered by various banks, you can spread your investment across different institutions, which can help mitigate the risk associated with bank defaults (which should not be a concern as long as each of your CDs is insured by the FDIC and less than $250,000).
Cons of a Brokered CD Ladder
Investing in brokered CD ladders has some downsides to consider.
The first is the risk associated with the broker, which can be mitigated by going through a name-brand broker such as Charles Schwab, E*Trade, or Fidelity.
The investor should then consider the CD’s issuing bank and check if it’s a reputable bank and has FDIC insurance.
Brokered CD ladders aren’t more complex or take more effort to manage than the traditional CD ladder, but they do offer more options and terms. If you have multiple short-term brokered CDs maturing at various times, this may require active management.
Lastly, liquidity on the secondary market is sometimes thin for brokered CDs. However, remember that it’s not even possible to sell bank CDs before their maturity, so brokered CDs at least have that liquidity option.
Pros and Cons of a Bank CD Ladder
Pros of a Bank CD Ladder
A bank CD ladder also offers consistent short-term access to cash. Similar to brokered CDs, you also get exposure to higher rates on longer-term CDs versus locking up your funds in a short to mid-term CD. However, these rates are not as high as brokered CDs.
Bank CDs also offer higher rates than savings accounts, providing a better return than simply leaving your money in a traditional savings account.
One of the main advantages of bank CD ladders is their simplicity. Since all the CDs in your ladder are issued by the same bank, it’s easier to manage your investment and keep track of your maturity dates. Plus, many banks offer automatic renewal options, which can make the process of maintaining your ladder even more effortless.
Cons of a Bank CD Ladder
On the downside, if you need the money before your CDs mature, you will pay an early withdrawal penalty, which is typically several months’ interest. This can eat into your returns and make bank CDs less attractive if you think you might need access to your funds before the CD matures. Some bank CDs do not even allow early withdrawal.
Additionally, longer-term CDs don’t always pay higher rates. This means that you might lock up your money for a longer period without receiving a significantly higher return, which could be a disadvantage if interest rates rise during the term of your CD. Of course, this can happen to brokered CDs too. As a rule of thumb, one should avoid investing in long-term CDs that offer lower yields than short-term CDs, unless you strongly believe that interest rates will be lower in the future.
While bank CD ladders are simpler and easier to manage, they also offer less flexibility and diversification compared to brokered CD ladders. For instance, you’re limited to the CDs offered by your bank, which may not provide the best rates or terms. Additionally, since all your CDs are with the same bank, you’re more exposed to the risk of that bank failing.
How to Choose Between Brokered CD Ladders vs. Bank CD Ladders
In conclusion, both brokered and bank CD ladders have their unique advantages and disadvantages. Your choice will depend on your financial goals, risk tolerance, and liquidity needs.
Brokered CD ladders offer more variety and potentially higher yields, but they require more active management and due diligence. On the other hand, bank CD ladders are a bit simpler and don’t require as much management, but they may not offer as high of a yield.
