Barbelled Bank Rate Strategy Offers an Alternative to Laddering CD Rates

Barbells vs. Ladders: Getting the Most Out of CD Rates

If you've used a laddered CD strategy in the past to help spread out your risk, you may want to consider a variation on this approach: a barbelled portfolio.

Managing CD Rates with a Laddered Approach

Laddering CDs means that you construct a portfolio of CDs with sequentially longer maturities. So, for example, you might have a CD maturing this month, another one due in a year, a third at the end of two years, and so on up to five years. Sometimes people happen into a laddered approach simply as a function of when they buy their CDs. Others, though, pursue the strategy deliberately.

Even if you have a lump sum to start out with, there are benefits to laddering your CDs by buying a series of different maturities. It spreads out your interest rate risk in a couple of ways. If rates go up, a laddered portfolio ensures that you haven't locked up your entire portfolio at lower rates for a long time. With some of the portfolio maturing every year, you will gradually be able to roll over to CDs offering the higher rates.

A laddered portfolio of CDs can also spread out your risk if CD rates fall. You won't have your entire portfolio maturing at once, so you won't be forced to roll over the entire amount when rates are down.

For Today's Bank Rate Environment: the Barbelled Alternative

The term "laddered" refers to a series of investments at regular time increments, spaced like rungs on a ladder. What, then, is a barbelled approach? Well, start by picturing a barbell as an object that is weighted on both ends and thin in the middle. That's what a barbelled portfolio is like. Instead of spacing the maturity of investments regularly, you weight those investments on the very short and the very long ends of the range.

A barbelled portfolio doesn't smooth risk out as evenly as a laddered approach, but it can be a good way to take advantage of certain anomalies in bank rates. For example, on money-rates.com recently, 1-month CDs were yielding as much as 1.05%, while some of the better 1-year CDs were yielding around 2.15%. At the same time, there were savings account rates that were offering around that 2.15% yield. When savings account rates are comparable to 1-year CD rates, there's no reason to lock in your money--unless you're afraid that high bank rates will be falling soon, which is certainly not the case today.

Using some of the highest CD rates found recently on money-rates.com in each maturity category, a laddered CD portfolio with equally weighted 1-month, 1-year, 2-year, 3-year, 4-year, and 5-year CDs would have an average maturity of 2.51 years and an average yield of 2.54%. If instead you barbelled the portfolio, putting half into one of the better savings accounts at 2.15% and putting the other half in a 5-year CD, you would have a similar average maturity of 2.50 years. However, your yield would be 2.825%, a clear advantage over the laddered portfolio.

The key to managing a low bank rate environment is being able to take advantage of small opportunities. Right now, a barbelled portfolio might be one way to do that.

Source:
Portfolio and Risk Management • Dec 14, 2007 • Finra Investor Education Foundation: http://www.finrafoundation.org/web/groups/foundation/@foundation/documents/foundation/p118409.pdf

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