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.

New CD Ladder and New Experiment

Posted By Paul

For those of you following the CD ladder postings that I have been writing recently, specifically:

Are CD Ladders Worth The Climb?
Recession coming? Time to lock in rates?

and

CD Ladder one year in

I thought you might find it interesting to know that I did a couple of things with my emergency fund in the hope that it would be educational to myself and other Frugalize readers.

I have one CD ladder and in the posting:

CD Ladder one year in

I estimate the amount of money that I would have made if I had I left the money in my savings account versus putting it in a CD ladder.

Well today I did three things with my savings account.

1) I created a new account and put the exact amount in it that I estimated above.
2) I started a second CD ladder.
3) I created ANOTHER new account and put the exact same amount that I put into my second ladder into this account.

So now I have two CD ladders and two savings account where each account holds the same amount that I put into the CD ladder. My plan is to periodically check in on the value of the CD ladders (where the value would include any penalties from early cash out) relative to their matching savings accounts.

The first ladder was started when the APY on my savings account was higher and the savings account rate has since fallen for the savings account. It will be interesting to see if that ends up being the case with my second ladder.

So keep reading for periodic postings on the CD Ladder vs. the savings account race.

Are CD Ladders Worth The Climb?

Posted By Paul

Another investment/savings device I've heard of is the CD ladder.

First a super quick overview of a CD:

The basic idea is that you go to some sort of bank and get a CD that has a specific term and interest rate. So let's say you get a $100 3 year CD at 5%, that means that your $100 will earn a guaranteed rate of 5% for the next 3 years. Super low risk, super not too exciting return, but there is a time and place for that type of investment.

So knowing this about CD's, what is the idea behind a CD ladder? Well the best way to understand the idea behind a CD ladder is to understand the two extreme cases that the CD ladder tries to avoid.

Let's assume you have $5000 and you'd like to put it somewhere really safe and earn a guaranteed rate of return.

Extreme Hypothetical Case 1:You buy a $5000 5 year CD which gives you an interest rate of 5%. Then in a month the interest rates jump up to 8%. Now you're annoyed because your money is locked up for 5 years at the now paltry rate of 5%.

Extreme Hypothetical Case 2:You buy a $5000 1 year CD which gives you an interest rate of 5%. Then in a month the interest rates plummet to 2%. Now you wish you had locked your money in at 5% for a longer amount of time.

So a CD ladder is just a way of covering both of these cases. Instead of buying a super short term or a super long term CD you instead create a ladder of CD's of varying terms. So now the scenario would be:

You buy a $1000 1 year CD.

You buy a $1000 2 year CD.

You buy a $1000 3 year CD.

You buy a $1000 4 year CD.

You buy a $1000 5 year CD.

You set each CD to roll into a 5 year CD when it matures. So after a year, the 1 year CD becomes a 5 yr, the 2 year has one year left, and so on.

So with this situation, let's say interest rates go up a lot. You get to say:

"Oh well, in one year I get to take advantage of that cool rate when my one year CD renews."

Also if the interest rates go down a lot you get you get say:

"Oh well, at least I have some of my money in that nice 5 year CD at the better rate."

It's nothing magical, just a way to hedge your bets, and not a bad thing to do if you have a chunk of money you want to put away for a rainy day.

One point to note is that ING (and I would imagine other banks) have the option of specifically setting up a CD ladder, where the interface asks you the total money you want to invest and the interval between them and it automatically sets up the ladder (not that it's hard to set up manually).

Also, some people don't like CD's because you have to lock your money up. The good news is that with all CD's that I've heard of you actually can cash the CD at any time, there is just a flat penalty for doing so (in my experience the penalty is often equivalent to the amount of interest you would make in 3 months). So if you set this up and then at some point in the future you have an emergency and need to access this money, you can cash out, eat the penalty and have your money back (plus any interest less the penalty) immediately.

My Emergency Fund

Posted By Paul

I've been thinking about my emergency fund recently. Specifically I have my emergency fund invested in:

-One share of Berkshire Hathaway B.
-Some fairly conservative mutual funds.
-A CD ladder
-An Internet Savings account.

I'm thinking that since my emergency fund is really more for having the money there in case of a rainy day, that I shouldn't worry too much about the returns. I'm thinking I might keep the Berkshire Hathaway share, CD ladder, and ISA, but ditch the mutual funds.

I was thinking of either starting a second CD ladder, or just putting the money into my savings account. The interest rate isn't exciting but perhaps for an emergency fund the safety is more important than the return on my investment.

Something for me to think about.

CD rates lower than savings rate?

Posted By Paul

If you have been following Frugalize you've noticed that I watch CD rates and that I've set up some CD ladders as a savings vehicle (to read earlier CD ladder posts click here).

I was intrigued by the fact that at ING currently a 12-36 month CD earns an APY of 1.5%. Yes that's a pretty low number, but what really intrigues me is the fact that the current APY for a normal savings account is 1.65%.

I don't have a ton of experience but I've never seen CD rates go LOWER than a normal savings account.

My thought is that if you are expecting your savings account to drop even further, then locking in a CD at a lower rate might actually seem appealing.

I found an article on Get Rich Slowly that discusses this:

CD (Certificate of Deposit) Rates: Current CD Rates at Online Banks

One thing is for sure, these are very strange times.

Savings Bonds and CD's starting to look good.

Posted By Paul

So has anyone else out there noticed that the interest rates for internet savings accounts have fallen to the point where it's harder and harder to get excited about them?

In fact my experimental investments such as my savings bonds and my CD ladders are starting to look really good (or at least better than my basic savings accounts). By locking in rates for the CD's and the savings bonds the somewhat blah rates of 2007 are beating the current rates on my savings account.

In fact Matt's wife forwarded this article to me on Clark Howard:

Buy Series I Bonds Before April Ends.

The article puzzled me a little bit since it says:

"Beginning in October, the rate will bump up to 6.06% for the following 6 months. That's a very competitive rate."

That struck me as odd. If you read my post on savings bonds you'll see that the I Bond rate is a mix of a fixed rate and an inflation rate. I don't see how you could predict the future rate of the bonds unless you knew both numbers in advance.

If you read the comments on the article you'll see a lot of discussion on the merits of this article, but the point I wanted to get across is that I learned something very useful and that is:

The argument that you shouldn't invest in CD's or savings bonds or other 'locked in rate' investments today solely because you can get the same rate with a savings account without having to lock your money away ASSUMES that the savings account rates of tomorrow will either be higher or the same as they are today.

For example, some of my emergency fund is in CD's that are locked in at 4.9% and even if I factor in the penalty of cashing the CD out early they're making a better return than my savings account.

So what does this mean? I guess it means that I'm going to watch the savings bonds rates very closely and maybe get some more if the fixed rate ever gets up to a nice amount. In addition, the next time that CD rates get up to a nice level I'll consider locking in again to take advantage of that (and now that I've seen it in action I totally get the idea behind the CD ladder).