Building a Ladder
of Saving Certificates
or Certificates of Deposit
Choosing the length of savings certificates or CDs is an important decision.
The issues of liquidity and the future direction of interest rates can
make the decision difficult. Longer maturity certificates usually provide
the highest return, but they also tie up your funds longer. Shorter maturities
provide flexibility to take advantage of rising rates, but usually with
lower returns. Ideally, you would want the highest current return coupled
with the ability to invest at higher rates if interest rates rose.
Creating a "ladder" of maturities is a way to create a "portfolio"
of certificates that will put you in a position to earn good rates and
invest at higher rates if interest rates rise. Simply stated, with this
strategy, you divide your funds into pieces and buy equal amounts of different
maturity certificates. Here is an example:
Let us assume you have $25,000
and want to buy certificates with maturities up to five years. The rates
on certificates are:
1 year 
1.05% 
2 year 
1.15% 
3 year 
1.30% 
4 year 
1.60% 
5 year 
2.15% 
By making initial
purchases of $5000 each of the different maturities, your average rate
would be about 1.95%. Each year, as a certificate matures, you would use
the proceeds to buy a 5year certificate. That way, as time went on, more
and more of your funds would be earning the highest rate and you would
still have annual liquidity. If rates rise, you have liquidity to buy
higher yielding certificates. If rates fall, you are still earning high
rates on your existing positions.
No one can accurately predict the future of interest rates. Using this
"Ladder of Maturities" strategy can help position you to benefit
regardless of the direction of interest rate changes.
