How to Build a CD Ladder
With the recent talk about CD rates being on the rise, I thought I'd write a few words about building a CD ladder. When you buy a CD, you are essentially loaning your money to the bank for a fixed period of time in return for a (typically) fixed rate of return. In general, longer terms are rewarded with higher returns. But you don't always want to tie up your money for the long term, do you?
The logical solution is to stagger your CDs such that you can commit to a longer term, yet retain some degree of liquidity. In practical terms, this means buying (say) five CDs of equal value, ranging from one year to five years in duration. After a year, the one-year CD (occupying the first 'rung' on the ladder) matures, the two year moves from the second rung to the first, and so on. At that point, simply roll the money from the now defunct one year CD into a new five year CD. If you repeat this process for four consecutive years, you'll be the proud new owner of a five year CD ladder (see below).
Not only does the increased liquidity of a CD ladder reduce the likelihood that you'll have to break a CD and pay a premature withdrawal penalty in the event that you need a bit of extra cash, but the fact that you're reinvesting a portion of your money every year helps to smooth out the peaks and valleys of interest rate fluctuations. Just keep in mind that you can create a ladder of whatever length you wish and, in a low-rate environment, you may want to keep a new ladder relatively short. After all, you don't want to be stuck with a slew of low-rate CDs when rates start to rise.
Oh, and in case you're curious, here's some info on how to track your CDs in Quicken.
Start of Ladder:
Rung 1: 1 year CD, 1 year remaining
Rung 2: 2 year CD, 2 years remaining
Rung 3: 3 year CD, 3 years remaining
Rung 4: 4 year CD, 4 years remaining
Rung 5: 5 year CD, 5 years remaining
End of Year 1:
Rung 1: 2 year CD, 1 year remaining
Rung 2: 3 year CD, 2 years remaining
Rung 3: 4 year CD, 3 years remaining
Rung 4: 5 year CD, 4 years remaining
Rung 5: 5 year CD, 5 years remaining
End of Year 2:
Rung 1: 3 year CD, 1 year remaining
Rung 2: 4 year CD, 2 years remaining
Rung 3: 5 year CD, 3 years remaining
Rung 4: 5 year CD, 4 years remaining
Rung 5: 5 year CD, 5 years remaining
End of Year 3:
Rung 1: 4 year CD, 1 year remaining
Rung 2: 5 year CD, 2 years remaining
Rung 3: 5 year CD, 3 years remaining
Rung 4: 5 year CD, 4 years remaining
Rung 5: 5 year CD, 5 years remaining
End of Year 4:
Rung 1: 5 year CD, 1 year remaining
Rung 2: 5 year CD, 2 years remaining
Rung 3: 5 year CD, 3 years remaining
Rung 4: 5 year CD, 4 years remaining
Rung 5: 5 year CD, 5 years remaining
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"How to Build a CD Ladder" was first published at fivecentnickel.com
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I developed an idea similar to this but using Series I savings bonds instead purchased monthly. The current rate is inflation adjusted at 6.73% and only requires a $100 initial investment as opposed to $5,000 for a 5 year CD. At the end of 5 years, I can start cashing in the bonds mopnthly penalty free and reinvest the cash or let it ride if the bond yield is still better than other rates. This gives me a similar flexibility at a better return than CDs with a lower entry point.
