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:
$5197.20

If it had been in a savings account at 4.4% APY for 14 months I would have:
$5255.20

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:

$5226.20

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.