How to Create Your Own CD Ladder

by Kevin M on December 24, 2012

in Investing

Lots of people are really disappointed with the rate of return they are getting on their savings. That’s even causing a lot of people choose not to save. After all, the alternatives are a lot more exciting. Instead of putting your money in the bank, you can spend it on things that you like, or take a chance at higher returns by investing in the stock market.

Both outcomes are the exact purpose behind the super low interest rates we are seeing. If you are out shopping and/or investing your money in stocks, you are doing exactly what policymakers want you to do with your money. But what if that’s not quite what you want to do?

If you like having money in the bank, and you want to get better interest rate returns than you are getting in money market funds and savings accounts, you may be interested in building your own CD ladder.

CD Ladder Strategy

What is a CD Ladder Strategy?

A CD ladder is a portfolio of certificates of deposit (CDs) with varying maturity dates. The best way to explain this is with an example. Let‘s say that you have $12,000 that you want hold in your savings. You want to invest it in CDs because they pay more than savings accounts or money markets. But at the same time, you don’t want to tie all of your money up in one CD for six months or a year.

You can create a CD ladder by investing $1,000 each month in a one year CD. Since you have $12,000, you can purchase one $1,000 CD each month for a year. After one year you will have a portfolio of CDs, with one renewing every month.

In effect, you will have created your own high interest rate money market fund, complete with FDIC insurance. Since you will have a CD renewing every month, you’ll be able to take advantage of higher interest rates as they become available. Should rates drop (which is hard to imagine considering how low they are right now) you will still have a large number of older CDs drawing higher interest rates.

Why Should You Want To Build One?

The reason for building a CD ladder is simple: money market funds and savings accounts are paying interest rates that are a low fraction of 1%. Because they are time deposits, CDs have higher interest rates. By laddering several CDs you avoid tying your money up in a single security.

Using A CD Laddering Strategy For Liquidity

In the example above, we described a CD portfolio in which one CD will be up for renewal every month. That will enable you to have access to at least some of your cash each month, with more coming available with every passing month. This will enable you to earn higher rates of return than you will get in savings accounts and money market funds, while still preserving some measure of liquidity.

If you want to increase the liquidity of your CD ladder, you can always invest in short-term CDs. You can build your ladder using three months or six months CDs, rather than one year CDs. That will improve your liquidity but it will also cut down CD rates of return, since shorter-term securities pay lower rates of interest.

CD Ladder Strategy For Interest Rate Return

You can also extend your CD maturities in order to increase the rate of return. You can do this either by investing in longer-term CDs, such as 18 month or two year CDs, or you can build a portfolio of CDs with various maturities.

As an example, you can make a CD ladder that includes maturities of six months, one year, two years and five years. Longer-term CDs will generally pay higher interest rates, while the shorter-term CDs pay less. The blending of the various maturities will create an even higher rate of return than you will get on a ladder composed entirely of short-term CDs. But with the longer term CDs you will also be losing liuidity, since longer maturities also mean slower renewals.

How Complicated Is It To Develop A CD Ladder Strategy?

Building your own CD ladder isn’t that complicated. In fact once you get it going it’s a completely passive undertaking. You can set up your CD ladder, then authorize your bank to automatically roll the CDs over as they mature. Typically, you will have them rolled over into CDs of the same term.

You can purchase CDs out of your savings account or bank money market fund. You can make your monthly purchase, or purchase a portfolio of CDs with varying maturities, either of which is a simple process. There will be little to do, and higher interest income to collect.

It will be like creating a high interest money market fund, but one that you control.

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© 2012 – 2013, Kevin M. All rights reserved.

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