Beginner Investor Series: How to Build a CD Ladder

I mentioned in my “About Me” page that my investment account is funded by money that I do not need in the short term.  For this investing account that I blog about I have no plans to withdraw any of the principle or profits until I have stopped working full time.  To give me such certainty in my plan I had to create another account that held my money that would not fluctuate month to month, much less day to day. (In my opinion, building this short-term account is a priority over building a trading account.)  For years I held this money in a money market at T. Rowe Price (Prime Reserve Fund).  My returns were generally 3-5% and I could write checks out of this account for major expenses such as a new car or a down payment on a house.  Once we bought our final house I no longer needed the check writing feature and could focus on getting a better return on my “safe” money.  I read an article on bankrate.com that explained the benefits of a CD Ladder.  You can link to the full article here and I’ll just summarize what I gained by reading it.

• A CD ladder is a collection of Certificates of Deposit that have staggered maturity dates.
• As each CD matures it is replaced with a new CD with a longer maturity date.
• The duration and interval of maturities can be flexible.
• A CD ladder has a few good benefits.  Replacing maturing CDs with long maturity dates usually brings in higher interest rates than shorter term.  Spreading out maturity dates gives you a greater chance to having all of your money reinvested at the time of a low period of interest rate returns.
• A CD ladder has negative points also.  Some CDs will be issued during low periods of interest rate returns.  You pay a higher penalty on money withdrawn on CDs with longer returns.

For me, the positives outweighed the negatives.  We (my wife and I) keep more than we probably should in our “safe” accounts, but neither of us has the most secure jobs.  She works for a small VC backed start-up and I work as a contractor for a Fortune 10 company where lay-offs happen far too often.  We make more money by taking these risks, but have to be more cautious with our short-term money.  I divided our savings into two accounts, 1/3 in a money market still and 2/3 in a CD ladder.  The money market money should get us through a short period of unemployment and if unemployment isn’t for a short period the CD ladder can be used although with an early withdrawal penalty.  Having multiple CDs with varying maturities gives me the option of only removing the money we need and leaving the other CDs untouched.

The question of how much should be kept aside is often debated. Generally advisors say anywhere from 3-6 months of expenses should be fine.  I think a big factor to weigh in is how easily you can find another job making what you want/need to make.  The higher you work into a company’s executive team, the fewer jobs are available to make a lateral move.  For that reason coupled with our tenuous jobs we keep more than 6 months of expenses set aside, out of equities.  Our money market would be used before we tap into the CDs.  Our CDs are staggered every 6-12 months with none more than 3 years out.  This plan will be utilized soon for us as my contract will not be renewed after this year and my job search has begun.  I have a CD maturing in a few weeks and will not replace it, but will move that money into our money market and if/when I find a new job will open a new CD again.

Since I make such strong returns in my investment account one might ask why I keep so much safely tucked away getting a smaller return.  The main two reasons are 1. I’m not foolish enough to think I’m bulletproof and won’t loose money some years and 2. My wife likes the security more than growth and since she gives me blind faith in our investments I have conceded this. 

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