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Plan Well, Retire Well

Saving and investing your money

Use a Ladder of CDs or Bonds for Future Cash Needs


I've been surprised by some of the feedback from recent workshops. Several people have said that the most important thing they learned was about this simple little investment strategy called laddering. So maybe you'd like to learn about it, too.

Laddering can come in handy any time you have a substantial amount of cash that you may need in the next few years. It will help you earn more interest without the risk of losing any money. And it's great for situations where you know you will need a certain amount of money every few months or every year. This might happen when:

  • You're building up your emergency fund, and you'd like to get more interest than a passbook savings account can offer.
  • You're approaching retirement, and you know that you'll need some cash each year, in addition to your pension or Social Security check, to cover expenses
  • You've saved toward your child's college, and they'll be starting in a year or so.

You can use CDs (bank certificates of deposit) or bonds to set up a ladder. Let's look at an example using CDs. Say you have $5000 in your emergency fund. You put $1000 in a one-year CD, another $1000 in a two-year CD, and $1000 each into a three-year, a four-year and a five year CD.

Step 1: Set Up Laddered CDs
Starting date: Jan. 1, 2010

Starting Amount

Length of CD

Maturity Date

$1000

1 year

1/1/2011

$1000

2 years

1/1/2012

$1000

3 years

1/1/2013

$1000

4 years

1/1/2014

$1000

5 years

1/1/2015

If you have to take money out of a CD before the maturity date, you'll pay a penalty. But the penalty may be pretty small if the CD has almost reached maturity. If you have an emergency that costs less than $1000, you can break just one of the CDs, and you can choose the one that will charge you the lowest penalty. The remainder of your money keeps earning the nice CD interest rates.

If you don't have an emergency, you renew each one into a five year CD when it matures. You've set up a rolling series of maturity dates, each now earning the higher rates earned by five year CDs compared to regular savings accounts or shorter CDs. You can check CD interest rates at Bankrate.com.

Step 2: Renew CDs as They Mature

Initial CD Term

Maturity Date

New CD Term

Maturity Date

1 year

1/1/2011

5 years

1/1/2016

2 years

1/1/2012

5 years

1/1/2017

3 years

1/1/2013

5 years

1/1/2018

4 years

1/1/2014

5 years

1/1/2019

5 years

1/1/2015

5 years

1/1/2020

Using a ladder for retirement cash needs would be slightly different. If you're working with a lump sum when you retire, you'd set up the CDs in step 1, and simply use the cash for expenses each year as the CDs mature.

But you can also begin setting up your ladder 3 to 5 years before your retirement date. Each year, you would purchase a 5-year CD, perhaps using funds from the sale of riskier investments. Once you reach retirement, you will begin to use the CDs as they mature, but continue to sell riskier investments each year to fund a new 5-year CD. This reserve would allow you to skip selling investment s for a year or two if the market is down, and use the cash you've built up. When the market rebounds, you could resume selling some investments each year to replenish your ladder.

So there it is. Laddering is simple, straightforward, easy to implement. What's not to love!



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