The Step Ladder Continuity
- how to maximize CD returns

The number one rule to money management is capital preservation. That is, you want to avoid taking big risks with your money.

If you've managed to save a little bit of money, you likely don't want to take any financial risks. You want a completely safe investment. But you'd also like to get a better return than the typical savings account. Enter the certificate of deposit, or CD.

You can think of the CD as a savings account in which you can't withdraw any of the money for a specified period of time, like 6 months. CDs are very common, and virtually every bank offers them.

Because you want to maximize the amount of interest you earn while owning CDs, your strategy needs to match the interest rate environment.

When interest rates are high and the expectation is that they will be going lower in the near future, the strategy is to lock in the rate using a long term CD. Buying 3 to 5 year CDs allow you to earn more interest, even after the rate falls. Pretty simple.

But when interest rates are low and the expectation is that they will be going higher at some point in the future, the strategy is more involved. You want to wait to get the higher rates, but you don't want to leave your money in the savings account, earning even less than the CD.

Building a CD ladder gets your money into CDs right away, and lets you take advantage of rising rates. You build a CD ladder using rolling maturity dates.

6 Month Rolling CD Ladder
with 3 year full cycle
CD Length Amount Rate Maturity
1 6 months $8,000 0.50% $8,020
2 1 year $8,000 0.78% $8,062
3 1 1/2 years $8,000 1.04% $8,125
4 2 years $8,000 1.28% $8,205
5 2 1/2 years $8,000 1.56% $8,312
6 3 years $8,000 1.85% $8,444

The example uses $48,000 for an initial investment, but you can use less. Just break up the total investment into equal amounts.

Here's how the example works. You buy 6 CDs all at once. The CD maturity dates are spaced out evenly, in 6 month increments. As you can see, the longer the CD, the better the rate. This is known as the rate curve.

Every 6 months, one CD will mature, and you will have earned the interest. You then purchase a replacement CD with a length of 3 years. The replacement CD will mature exactly 6 months after the last CD in the ladder.

But since expectations are that rates will rise, you should get better and better rates as you continue to replace CDs. Here's how the CD ladder might look over 6 years.

6 Month Rolling CD Ladder
with 3 year full cycle
CD Length Amount Rate Maturity Time
1 6 months $8,000 0.50% $8,020 6 months
2 1 year $8,000 0.78% $8,062 1 year
3 1 1/2 years $8,000 1.04% $8,125 1 1/2 years
4 2 years $8,000 1.28% $8,205 2 years
5 2 1/2 years $8,000 1.56% $8,312 2 1/2 years
6 3 years $8,000 1.85% $8,444 3 years
7 3 years $8,000 1.99% $8,478 3 1/2 years
8 3 years $8,000 2.20% $8,528 4 years
9 3 years $8,000 2.58% $8,619 4 1/2 years
10 3 years $8,000 2.96% $8,710 5 years
11 3 years $8,000 3.12% $8,749 5 1/2 years
12 3 years $8,000 3.98% $8,955 6 years

As long as rates are rising, keep rolling CDs to new 3 year terms. Once expectations are that rates have peaked, and are likely headed down, you'll want to lock in the higher rate. Simply purchase replacement CDs with longer terms, like 5, or even 7 years. You'll still be earning the higher interest, no matter how low rates go.

Another big advantage to the CD ladder is that you don't have the entire investment locked up for years. In the example, if you need money for something, you know that $8,000 will be available every 6 months, even though all $48,000 is invested in CDs.

The example used a 3 year cycle, with 6 CDs at 6 month intervals. But you can vary these components to fit your own situation.

Typical CD Ladder Components
cycle between 2 and 5 years
CDs between 4 and 8 CDs
interval between 6 months and 1 year

After you setup the CD ladder, it's a fairly passive investment. You only need to take action once every 6 months, or whenever one of the CDs matures.

One final tip. Online only banks tend to have the highest interest rates. Since the money just sits there, you don't really need a local branch.

So when you need a totally safe investment for part of your savings, check out the CD ladder, and step up your interest.