This blog contains some simple tips and advice from two regular guys. We're not accountants, financial advisors, or brokers, so follow, ignore, or discuss our ideas as you see fit.

Monday, February 25, 2008

The CD Ladder, one year in.

Posted By Paul

One of my first posts to Frugalize was when I was considering setting up a CD ladder.

Here is the link to the original article:

Are CD Ladders Worth The Climb

So if you've been reading some of my other posts you've noticed that I have been considering putting more money into CD's. I realized that a natural thing to do would be to take a look at the CD ladder that I already set up and see how it's actually doing (vs. what I would have made if I had left it in my savings account).

So first a little background in my CD ladder. It is through my Internet Savings Account and my initial deposit was $5000 back in November of 2006. Here was the initial set of CD's:

A: $1000 in a 1 yr CD at 5.1% APY.
B: $1000 in a 2 yr CD at 5.0% APY.
C: $1000 in a 3 yr CD at 5.0% APY.
D: $1000 in a 4 yr CD at 5.0% APY.
E: $1000 in a 5 yr CD at 5.0% APY.

Now currently I'm 14 months into it so my ladder looks like this:

A: Matured after one year and is now a 5 yr CD at 4.9%
B: 1 yr to go until maturity at 5.0% APY.
C: 2 yr to go until maturity at 5.0% APY.
D: 3 yr to go until maturity at 5.0% APY.
E: 4 yr to go until maturity at 5.0% APY.

So compared to my current savings rate (which is 3.4% APY) these interest rates look pretty sweet, but let's take the fees into account if I were to take my money out today.

Each CD has a penalty of 6 months of interest for early redemption. So if I were to cash the CD's in today I would get:

A: $1,038.54
B: $1036.96
C: $1036.96
D: $1036.96
E: $1036.96

For a total of $5186.38.

So now since the CD ladder has been around for 14 months (1.16 years) then to calculate the APY:

The APY is X in the equation:

5000 + (5000*(1.16*x)) = $5186.38

Which gives an APY of 3.2%

So how does that stack up? Well currently the APY on my savings account is 3.4% (and it has been falling over the last year, I think that back in November of 2006 is was around 4.4%).

So it's not possible to calculate exactly what the $5000 would have grown to over the last 14 months since I don't have the historical data of my shifting interest rate, so I'll just ball park it:

If it had in a savings account at 3.4% APY for 14 months I would have:

If it had been in a savings account at 4.4% APY for 14 months I would have:

So from the savings account I would have ended up with some amount between $5197.20 and $5255.20. I'm going to just average them to get a basic comparison. Let's say that in the savings account that after a year the $5000 would be worth:


So now let's compare:

CD Ladder Return = $186.38
Estimated savings account return = $226.20

So based on this estimate after a year my CD ladder is trailing the savings account estimate by about $40.

So what does this mean? Well it means that the early cash in penalty definitely plays a factor, but it's also interesting to note that after the relatively short period of 14 months into the ladder (where the penalty is 6 months of interest) that the ladder is quickly approaching the savings account. As time goes on the penalty of 6 months will become less and less significant of a factor in the equation and it becomes more a race of relative rates.

So overall I think the CD ladder has been a great experiment and a good decision. I'm VERY excited to see what the two year update is.

No comments: