How to Setup Laddered Certificates
Mark Andersen from Financingyourfamily.com is a banking professional who loves what he does and shares his insight into a little-known banking strategy.
A common situation that befalls the members I work with goes like this:
- A close relative passes away
- Said relative leaves a substantial inheritance
- A receiver of the inheritance doesn’t want to blow the inheritance, so they come see me.
Generally, they do not want to spend the money, they want to save it.
They don’t want it easily accessible, but they would like to change their mind on that in a few months or a few years, and they are not interested in uninsured investments (stocks, mutual funds, etc.)
The strategy I suggest is known as Laddering, and it’s a great way to make CDs more liquid without sacrificing interest.
How does one ‘ladder?’
Let’s say that the inheritance was $40,000. In a 12 month CD, that would earn a good amount of interest, but since we want access to a good amount in 3 months, that one-year CD would be foolish for the full $40,000. What we’re going to do is break that $40,000 into 4 $10,000 chunks, and we’re putting one in a 3 month CD, one in a 6 month CD, one in a 9 month CD, and one in the 12 month CD. This is the first four rungs of the ‘ladder.’
The interest on shorter-term CDs is less than on longer-term CDs, so when the first CD comes due, we take the $10,000 plus interest and we put it in another 12 month CD. Now our portfolio looks like this: 3-month CD paying 6 month’s interest; 6-month CD paying 9 month’s interest; 9-month CD paying 12 month’s interest; and a 12-month CD paying 12 month’s interest. We’ve now put the newest rung on our ladder.
Once the first 12-month CD comes due the ladder cycle is considered to be complete.
I’ve seen several variations to help fit some unique needs. There was a retired woman who had a lot of money from her husband, and had a monthly ladder in place where the interest would deposit into her checking account when the CD came due. The result was that she got roughly a $600 paycheck on top of her social security and pension every month, and had more money than she knew what to do with. Her grandchildren are adequately spoiled.
I also worked with a college student who had a great job (he could afford to go to school from just what he earned) but he took out student loans every semester anyways. His ladder was every 6 months (every semester) and he just put his student loan money in there to earn interest. Because of the grace period on his loans before he had to pay interest, he was able to get out of student loan debt and have an extra $1000 in his pocket on graduation.
You can be pretty creative with laddered CDs, and if you have a solid banker who you trust you can even turn a safe, federally-insured profit from them.
Although this is a great strategy to get decent returns and liquidity out of CDs, online savings accounts have begun to take over this role. With many online savings accounts giving upwards of 5.25% and 1-year CDs giving around 4.85% as of today (BankRate.com), they are no longer as attractive as they used to be.
While I agree with you that most online savings accounts beat the rates offered with CDs in today’s market, you never know when rates will adjust.
Using a CD can allow you to hedge against rates dropping with the online savings accounts. Personally, I have been sticking with the online savings account for my more liquid savings because of what you mentioned as I am not too concerned with the online savings rates dropping significantly.
The other thing a laddered portfolio does is limit access to funds in a much greater sense, which helps people like my wife who spend it if they have it.
That is actually a great point. Some people are too tempted when the money is in a very liquid online savings account and that could be a bad thing.
You bet. The mindset of the investor absolutely has to be considered.
This is the same reason I don’t always stick to the “don’t pay extra towards your mortgage argument” even if mathematically would be better if they didn’t. There is something to be said for peace of mind.