Certificate of Deposit Laddering
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Certificate of Deposit Laddering

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CD laddering is a way to dollar cost average your CD portfolio to smooth and hopefully maximize your CD return over a period of years. It isn't right for every investor or in every interest rate environment, but it is a strategy worth understanding and considering.

Like dollar cost averaging into an equity security, you can reduce reduce the risk of adverse interest rate changes by dividing your intended CD investment into multiple CDs coming due over various time frames, instead of buying a single CD.

The basic premise of CD laddering is to always have a CD that is coming due in 1 year. 

Non-Laddered CD Investing

Suppose you have $100,000 to invest.  If you were to have invested this entire amount in 2006 in one year CDs, your returns would look something like the following:

Rate

Initial Investment

5.55%

End of Year 1

4.80%

End of Year 2

4.30%

End of Year 3

3.75%

End of Year 4

2.20%

End of Year 5

1.20%

As you can see, the return starts off okay but at the end of the fifth year (2011), interest rates drop and you're stuck investing at 1.2%

CD Laddering

Had you broken the $100,000 into 5 different investments and placed $20,000 each in different term CDs (ranging from say six months to five years), you would have suffered significantly less from the low interest rates in 2010 and 2011, and presumably you would still have some of your money earning higher interest from the longer term CDs.

What laddering does do is smooth out your earnings potential.  If rates are high today but drop precipitously in one year you will still have some higher yield, longer term CDs in your portfolio to boost your earnings.  Effectively, laddering cushions a portfolio from the steep drop in rates like the one that we have recently seen.  Laddering, of course, becomes less effective if rates remain low for an extended period as all of your CDs of various durations will roll over into lower rate replacements.

In some years the laddered approach does better and in other years the non-laddered approach wins.  In an extended low-rate environment like today, a laddered approach may be the best way to go. The laddered approach allows investors to earn a better yield on longer-term CDs while still keeping some money relatively liquid in shorter-term CDs should rates begin to rise. Keeping all of your money in shorter duration CDs is better when you are sure interest rates are going to rise, or rates have already begun to go up. Keeping all of your money in longer-term CDs is prudent if you expect rates to plunge, as they did starting in 2008. But, since most of us are not prescient enough to forecast the direction of rates, laddering provides a safe alternative that doesn't require a crystal ball.

Another advantage of laddering is that money comes due every year. Investors that may need the cash at some point, have access to a portion of it every year without having to break a CD and incurring any resulting penalties.

Designing a CD Ladder Today

If one wanted to design a hypothetical CD ladder today, here's how it might look. To get the best rate, we'll use CD rate data provided by BestCashCow. I've looked at both local banks and credit unions (I live near Boston) and online banks to get the best rates for each term. Although this requires a bit of driving around, I've made sure using BestCashCow data that all of the banks have branches relatively close to where I live - within 4 miles.

Investment amount of $100,000

Term Bank Rate (APY) Amount
12-Month CD Discover Bank 1.10% $20,000
24 Month CD OneUnited Bank 1.30% $20,000
36-Month DanversBank 2.00% $20,000
48-Month City of Boston CU 2.27% $20,000
60-Month DanversBank 2.40% $20,000

 

This is the best portfolio I could build. The rates are terribly low and I'm not happy about locking money away for 5 years at 2.40% APY but for all we know, rates might be even lower in five years. After all, in 2008, everyone expected hyper-inflation and soaring rates while the exact opposite has happened. If rates do go up, I can reinvest the money that comes due from the one and two year CDs.

To begin building your CD ladder, spend some time investigating the best CD rates. Get the best rates you can from local banks and credit unions and online banks and then ladder away.

Ari Socolow
Ari Socolow: Ari Socolow is the Chief Economist and Editor-in-Chief at BestCashCow. He is particularly interested in issues relating to financial literacy and bank transparency. Since co-founding this website in 2005, Ari has been frequently cited in the media as an expert on local and national savings accounts, CD products, mortgage and loan products and credit card rewards products.
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Reviews

  • H. Jones

    September 17, 2013

    @Frank

    Good luck! When your oil trusts go to 0% I'll be sitting pretty with my cash. CDs are for money you don't want to lose. A fool and his money are soon parted.

  • Frank Quattrone

    November 22, 2012

    These CD rates are older than my great-grandma. Good luck getting anything in CDs above half the rate of inflation. Go take a look at REIT stocks or oil trusts, they can pay 12-14% annually. That's more than you'll make in 20 years by wasting your time laddering CDs that pay 0.5%.

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