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A reader named Joyce recently wrote in to ask about managing a CD ladder in a low interest rate environment. She noted that interest rates have been falling, and that she’s not crazy about locking her money up for minimal return. She’s thus wondering if she should continue to plow her money back into her ladder when CDs mature, or if she should pull the money out of CDs entirely.
What is a CD Ladder?
For starters, let’s define what we’re talking about. A CD ladder is simply a set of long(er) term CDs with staggered maturity dates. For example, you might have a set of twelve 1 year CDs, each maturing during a different month throughout the year. Alternatively, you might have five different 5 year CDs, each maturing a year apart.
Regardless of how you set it up, the attraction of a CD ladder is that it allows you to retain some degree of liquidity (due to the staggered maturity dates) while earning a higher interest rate than you could otherwise get with a high yield savings account. In addition, the staggered maturity dates help smooth out interest rate fluctuations.
Managing Your CD Ladder
Returning to Joyce’s question, I agree that the current interest rate environment is frustrating — a quick glance at my list of online savings account interest rates will show you just how bad things have gotten. But should she abandon her ladder?
The answer to this question depends on a number of variables, such as the term of the CDs, how soon this money might reasonably be needed, etc. From the sound of her e-mail, Joyce is holding fairly short-term CDs (6-12 months), so she’s not facing a lot of risk by renewing now. If interest rates suddenly move upward (seems unlikely, but I’m no economist) she wouldn’t be stuck holding the bag for very long.
Another thing to keep in mind is that, as I noted above, one of the main points of maintaining a CD ladder is to smooth out the ups and down in interest rates. Yes, interest rates are down right now, but the ladder means that: (1) only a fraction of your holdings are being renewed at any one time, and (2) the other, higher rate CDs will soften the impact of these low rates.
There are, of course, some alternatives. One would be to shop around for better rates elsewhere. Joyce’s money is currently at ING Direct, which is bringing up the rear right now in terms of interest rates at online banks. Of course, this adds complexity, so it might not be worth the trouble.
Another possibility would be to just let this rung on the ladder sit on the sidelines in a savings account until rates improve — maybe create a subaccount to make sure it doesn’t get spent. The problem here is that savings account interest rates are typically even lower than CD rates (that’s certainly the case right now at ING Direct), so there’s not much to be gained unless she switches to a bank whose savings rate is higher than ING’s CD rates.
So, dear readers, what did I miss? Do you have any advice for Joyce?