How People Build Interest Rate Ladders
A simple approach
to get higher, stable interest income on shorter-term assets
What do people mean when they discuss "laddering CDs" or "laddering fixed interest products"? They are usually referring to a strategy that people will use to maximize predictable interest income for shorter-term assets but that will still allow some liquidity. A "ladder" typically refers to the purchase of a number of interest-bearing products, like bank CDs or MYGAs of varying durations and interest rates. Generally, products with longer durations pay higher interest rates, but reduce liquidity for the owner. By laddering fixed interest financial vehicles, people can increase their interest income on savings, protect against interest rate volatility, and still build in a measure of liquidity for your money in case of emergency.
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Set aside a small amount for emergencies
Generally, advisors recommend having 3 to 6 months' worth of savings that can be accessed at any time.*
Decide how long to structure a ladder
Generally, people structure a laddered interest strategy anywhere from 3 to 7 years. In a normal interest rate environment, a longer planning period will generally allow an individual to earn higher rates. However, it also means that a higher percentage your savings may not be immediately accessible without paying a penalty or sacrificing overall returns. For discussion purposes, we'll assume we're building a 5-year ladder.
Determine the frequency at which each investment in the ladder matures and is reinvested
Some people, based on total size of their savings and minimum required investments may choose to structure a 5-year ladder at intervals as short as three months. To keep this as simple as possible, let's assume the desired frequency of reinvestment is once a year.
Divide the total assets equally by the number of reinvestment periods
Suppose a person wants to place $50,000 in short-term savings in a 5-year ladder with an annual reinvestment cycle. This means that the person will put $10,000 in each of five different savings vehicles. The person could hypothetically put $10,000 in each of the following: a 1-year bank CD, a 2-year bank CD, a 3-year bank CD, a 4-year MYGA, & a 5-year MYGA.
As each instrument matures, reinvest at the maximum length of the ladder
One year later, when the 1-year bank CD matures, the person would reinvest the $10,000 plus interest in a 5-year MYGA. Two years later, when the 2-year bank CD matures, the person would reinvest the funds in a 5-year MYGA. This strategy allows a person to progressively benefit from higher interest rates, to protect against interest rate volatility, and to have the regular opportunity each year to access savings without penalty if personal circumstances change.
*Here's How Much Money You Should Really Save For Your Emergency Fund, Forbes, April 15, 2016
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The information above is intended for use by the general public and is not individualized to address any specific investment objective. It is not intended as investment or financial advice. We encourage you to consult with an advisor who can tailor a financial plan to meet your needs.