Managing CD Rates: The Back End of the Ladder

With bank rates generally still quite low, depositors have to be especially shrewd about getting every extra basis point they can for their money. This can mean shopping around, negotiating for a better deal, and using more active cash management techniques. One such technique is using CD laddering to get short-term liquidity with long-term CD rates.

A Different Way to Look at Laddering CDs

Many people have heard of the basic CD laddering strategy: structuring a portfolio of CDs with a series of maturity dates at regular intervals, like the steps on a ladder. Other approaches carry similarly descriptive names. A barbelled portfolio would be heavily weighted on the extreme ends, or at very short- and very long-term maturities. There are several reasons for using a technique like laddering. You can manage risk, synchronize the availability of cash with expected needs, or get the most out of the prevailing structure of CD yields.

Generally, we think of laddering as setting up a portfolio of CDs all at once, buying CDs of different lengths to create the desired laddered or barbelled effect. However, there is a different way to ladder CDs. Instead of buying CDs of differing maturities at one point in time, what about buying CDs of the same length at different points in time? For example, suppose you bought a 5-year CD at the start of every year. Eventually, you would have a CD maturing every year, which you could either use for immediate cash flow needs or roll over into a new 5-year CD. You would be getting at least partial liquidity on a year-to-year basis, but at a 5-year CD rate rather than at a lower 1-year CD rate.

Example: Getting Short-Term Liquidity with Long-Term CD Rates

A good example of how this might work would be with an emergency fund. Suppose you've saved up a good reserve of cash to meet unexpected expenses. Under most circumstances, you won't have to spend all of this reserve at once, but you don't know from year to year how much you'll have to dip into it.

According to national average bank rates from the FDIC, if you chose to keep your entire reserve available at all times, you could expect to earn about 0.20% per year in a savings account or 0.33% in a money market account. If you decided you could live with the money only becoming available once a year, you could earn 0.90% from putting it all in a 1-year CD.

On the other hand, if you bought a series of 5-year CDs over a 5-year period, you'd be earning a higher interest rate on CDs--currently, 2.15% on average. And if, rather than settling for the national average, you looked for the most favorable rates on Money-Rates.com, you could be earning even more. At the same time, you'd still have at least part of your fund becoming available every year, so you could decide at that point whether to roll it over or apply it against new expenses.

In this way, the back end (that is, the maturing end) of a laddered CD portfolio can provide you with near-term liquidity at long-term CD rates. You can amplify this advantage even further if you shop for the highest interest rates on CDs on Money-Rates.com when starting your ladder or rolling money into a new CD.

 

Source:

Weekly National Rates and Rate Caps • http://www.fdic.gov/regulations/resources/rates/index.html • Federal Deposit Insurance Corporation

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