Money Stuff: Laddering CDs/Treasuries/Bonds

Earning Higher Returns and Keeping Liquidity

So, I?ve talked about the importance of liquidity and earning a solid rate of return. Now, it?s time to learn your lesson on how to do both. To do that, all you need to do is ladder your investments. What?s a ladder? It?s a method of buying bonds or CDs so that you maximize your return and still keep your liquidity.

Perfectly liquid would mean that you have access to all of your savings so that if you needed to do so, you could withdraw it all and use it to buy a car, a house or a really nice hat. However, by being perfectly liquid, you aren?t earning as nice of a return as you could be. So, instead, you invest all of your money in a two-year CD/Bond/Treasury so that you can earn a rate of return greater than a simple savings rate. Unfortunately with this investment strategy, if you need any of that money, you would more than likely lose your planned rate of return due to early withdrawal or selling before maturity.

Laddering is taking a chunk of your liquid money each month and buying an instrument that matures at the length of the ladder that you want. So, if you want a two-year ladder, you?d use part of your savings to buy a two-year CD. Next month, you do the same. And the following month. And the following month. (No, this isn?t a record skipping.)

The point of this is that you still get the benefits of the two-year CD/Bond/Treasury once you?ve invested all of your money. However, because you invested one twenty-fourth of your money each month instead of it all at once, at the end of each month, you still have access to a part of your money.

Then, once your CD/Bond/Treasury reaches maturity, you can reinvest it (at the current two-year rate) or keep it, if you need the extra cash. Yes, you won?t get all of your money back all at once, but as you?ve been slowly investing it in the first place (over a two-year time frame), if you?ve needed any of it, you can hold purchasing your CD back. It?s rare you would need your whole savings anyway, and if it is a desperate time, you can always take the withdrawal penalties and buy that Stephen Strasburg rookie card.

So, here?s a quick recap on how to ladder your savings.

1. Divide your savings up into equal buckets.

With the minimum investment on U.S. Treasury bonds at only $100, you can ladder for two years for only $2,400.

2. Look for good rates.

Unfortunately, right now U.S. treasuries are not providing that great of a return (as it is 0.6% for a two year bond.) So, turn to corporate bonds or bank CDs. Right now Ally Bank has a 1.49% one year CD offer. This is obviously a higher rate and the ladder would only take a year to invest and unwind.

3. Buy a CD/Treasury/Bond once a month.

With your $2400, now you can buy one $200 CD a month for the next year to construct your ladder.

4. Evaluate the CD/Treasury/Bond each month.

At the maturity of your instrument, take your return and then look at rates again to see where you should reinvest. If it?s with the same CD, that?s easy. If not, go after the better rate. (Which is also a protection against inflation. If inflation and interest rates start to rise, the maturity of your assets will allow you to reinvest at the higher rates after each asset matures.)

So, that?s laddering in a nutshell. Just be patient and you can get a higher return as well as keeping some liquidity.