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Laddering

What is Laddering of CD's?

The simplest example of laddering a CD portfolio is taking $50,000 and buying five $10,000 CD's i.e.; one $10,000 CD for a 1 year term, another for a 2 year term, yet another for a 3 year term, and so on until you have the last CD maturing 5 years in the future. This can be done for any sequence of maturities. For example, 6, 12, 18, 24 and 30 month CD's. When the shortest term CD matures at 1 year in our first example the proceeds are then invested for the longest term of your strategy (5 years in this first case). The idea is to always have something maturing in the short term but to also have some portion of your portfolio with longer maturities to take advantage of the higher rates offered.

The 1 thru 5 year ladder depicted is only an example. You can do this by spreading your money out in many different ways. A ladder structure could be 3, 6, 9, 12, 15 and 18 months. It could also be accomplished by buying a $500 CD every three months with a long term (higher rate) maturity. Eventually you would have a CD maturing every month and could take advantage of current rates, if they are going up. Laddering of CD's is much the same as diversification of a stock portfolio. This strategy spreads your risk that interest rates may go up or down. If rates are going down, your entire investment won't re-price to lower rates at maturity. And, if rates are going up a portion of your portfolio will always be maturing so you can take advantage of higher rates.

It can also improve the yield you earn on your investments. In today's market (February 2009) a six month CD is paying on average 1.75% and a five year CD is paying 2.77%. In the simplest of terms if you bought one of each your blended yield would be 2.26% for at least the first six months of your investment. That is better than going short with only the six month CD, but not as good as going long with the five year investment. It however, gives you the flexibility to re-invest the six month CD at a higher rate if rates go up over the next six months. It also cushions you if rates go down over the next six months.