CD Laddering Strategies in a Low-Yield World

After three years of record-low interest rates, few advisers are pushing their clients to build CD ladders. It's a method of opening numerous certificates of deposit that will mature at various times, which allows investors to create a cash-flow scenario with new CDs maturing on a regular basis.

However, there are some cases in which investing in CDs with varying maturities remains a viable option, especially for people who want to keep their money safe, federally insured and easily accessible.

"The CD ladder is always going to be more attractive for the more conservative investor," says Marsha Baker, a CPA who teaches consumer finance at Lindenwood University in St. Charles, Mo. "However, I think a CD ladder is a great place to park emergency funds, no matter what your risk tolerance might be."

Who Should Stagger CD Maturities?

Like Baker, Deana Arnett, a CFP with Financial Planning Services in Manassas, Va., says she recommends CD ladders for people who have a well-established cash reserve fund of about six months' income. Because such an emergency fund usually has more money than most people want to keep in a savings or money market account, Arnett recommends keeping one or two months' income in a savings account and investing the rest in CDs with staggering maturities.

However, current interest rates make the strategy questionable for many advisers. "It's not that building a CD ladder is bad. Rather, it is the poor yields on CDs," says Dirk Anderson, a principal at Human Investing in Lake Oswego, Ore.

For instance, core inflation is around 3% per year. But the average 12-month CD pays about 0.5% interest, the average 10-year CD pays about 2% and the average 20-year CD pays about 3%.

"CDs just won't keep pace with the increasing cost of living, and when rates do rise, CD holders will get crushed if they only have long-dated CDs," Anderson says.

Determining whether a CD ladder is a good idea depends on the purpose of the funds, says Kathryn Garrison, a financial adviser with Moss Adams Wealth Advisors in Seattle. For instance, someone who has many more working years ahead of them may set aside $60,000 as an emergency fund. The money can be invested into three-, six-, nine- and 12-month CDs. "If they are laid off, they have money coming due to cover living expenses every three months or so," Garrison says. "If a CD comes due and they don't need the money, they can roll it into another 12-month CD."

A midcareer worker who needs to pay for a child's college tuition can ladder savings into CDs that will mature as the tuition payments are due, Garrison says. And a retired person can ladder CDs over longer terms, such as six months, 12 months, 18 months and 24 months, in order to have a healthy cash cushion, she says.

If a CD ladder seems like a smart strategy for your money, it's easy to create. Determine how much money you can invest in CDs and how frequently you want access to part of your money, such as every year or every few months.

"Think of it like a conveyor belt," says Adam Koos, CFP and president of Libertas Wealth Management Group Inc. in Dublin, Ohio. "You can make the belt as fast or slow as you'd like. You can buy CDs in increments of six months, or you might buy CDs in one-year increments.

"The former would be a quicker conveyor belt, where you've got a CD falling off the belt more often, which gives you a more frequent chance at buying new CDs at hopefully higher interest rates than you're getting now," Koos says.

While purchasing CDs in longer increments (one-year, two-year, three-year and so on) has traditionally paid better interest rates, that's not the case in the current market. By purchasing CDs in shorter maturity time frames, you'll have money frequently coming due, and you will be able to reinvest more quickly into higher-interest CDs when rates do go up, Anderson says.

"The objective of CD laddering is to take advantage of three things: current interest rates, future interest rates and some means of periodic liquidity," Koos says.

Try a Savings Account?

These days, CD investors are hardly being rewarded for locking into longer-term CDs. For instance, one-year rates average around 1% and five-year rates may be up to 1.75%. Because interest rates are currently so low, most advisers recommend purchasing shorter-term CDs, with the longest term of your ladder only one or two years. If you continue to roll over maturing CDs into another one- or two-year CD, you'll have incremental CDs maturing every few months and ready to invest again when interest rates rise.

"If you are going to use the CD ladder for emergency funds, the main purpose for those funds is having them available when an emergency happens," Baker says. "If you can gain some interest on the funds, that's a bonus."

While CD ladders can help ensure you have cash available at a given time for a specific need and also allow you to take advantage of interest rate increases over time, carefully consider whether the strategy is right for you right now.

"It may be that chasing after a few extra tenths of a percentage point is more trouble than it's worth, and you'd be better off just placing your money in a high-interest rate savings account, especially if you aren't really sure when you'll need it," says Garrison. "It can be time-consuming to manage a CD ladder, and the difference between three- and 12-month CDs is so small right now, it may not be worth the effort.

"You may actually get