Laddering CDs when rates are low
By Laura Bruce • Bankrate.com

If a portion of your portfolio is devoted to CDs, you may be wondering what to do with the CDs that are maturing in this low-rate environment. Judging from our e-mail, many of you have laddered CD portfolios and are questioning the wisdom of buying a three-, four- or five-year CD at these rates.

For those who aren't familiar with a CD ladder, it's a way to take advantage of interest rates spread over several maturities without sacrificing liquidity.

Suppose you have $20,000 to invest in CDs. A traditional CD ladder would be for five years and it would have five rungs: one-year, two-year, etc. You could invest $4,000 in each rung.

After one year, the first CD matures and the others move down a year. In other words, the two-year CD is now due in one year; the three-year CD is due in two years, etc.

The money from the CD that has just matured is rolled over into a five-year CD. Each year you replace the rung that's farthest out, in this case the five-year rung.

Safe and sound
At today's rates, your return on a five-year CD would be about 4.1 percent.

Not very appetizing, but in a stick-to-your-guns ladder, that doesn't matter.

"The purpose of a CD ladder is to eliminate a lot of the emotional decision-making that goes on within an investment or savings plan while evening out the highs and lows that invariably come with interest rate cycles," says Jason Flurry, a certified financial planner with Planmark Capital Management in Alpharetta, Ga.

"We are truly in unique times and they may warrant exceptions to the general rules. In most cases, however, it's advisable to follow the laddered plan and put aside speculation and forecasting."

Bankrate financial analyst Greg McBride agrees; if you have the ladder in place, stick with it.

"This is when the ladder is really paying dividends. You're only reinvesting a portion of it when yields are real low. That balances with a couple of years ago when you reinvested at a high rate of return. Over time the ladder smoothes out the peaks and valleys," says McBride.

If you started a five-year ladder two years ago when the national average for a five-year CD was 6.15 percent, you're reaping the benefits of a higher rate environment.

But the person who started a five-year ladder a year ago when the five-year had dropped to 4.68 percent may be regretting getting a late start in the interest rate game.

Don't feel bad. There are plenty of people who would love to be earning that on their investments.

But what if you are just thinking of building a CD ladder? Is it smart to build it out to five years?

Nope. Not now. You can begin the process but keep the ladder short.

"Interest rates will have to go up but I wouldn't want to be locked in longer than six months or a year at the most," says John Sestina of John E. Sestina & Company in Columbus, Ohio.

McBride agrees, don't be in a big hurry to lock up longer maturities.

"I would not go any further than one year out. If the goal is to begin reinvesting each matured CD in a five-year CD, establish shorter maturities now, three months, six months, and one year. As money matures and yields begin to rebound, take larger steps and invest in the longer maturities."

Keep the ladder wet
Probably the most important thing to keep in mind when laddering a portfolio of CDs is to make sure the maturities jive with your cash needs. It's great rolling over CDs and their interest, but it's more important that your money is liquid when you need it. Penalties will seriously crunch your returns.

While a five-year ladder will allow you to take advantage of the best interest rates offered, your ladder could be shorter if it makes you more comfortable. Likewise, the rungs should be whatever maturities suit your liquidity needs.

For those of you looking to replace a rung, it may be tempting to sit on the sidelines for a couple months to see if rates rise a bit. That's understandable, but don't drag it out.

"CD laddering is the best way for a CD investor to achieve superior results over time while minimizing risk," says Flurry.

"Tinkering too much with the plan usually results in regrets and lost opportunities. My advice is sit tight if you must, but don't wait too long. Postponing reinvestment can be stressful and costly.

"The laddered plan needs money to work. Give it a chance and hope this year's addition is the lowest you have to accept for years to come."

-- Posted: July 29, 2002