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| Dave Rathbun |
 Posted: Tue Apr 12, 2005 8:57 am Post subject: Buying a Ladder |
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CFO
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I did a quick search, and nobody seems to have explained this concept yet, so I'm going to give it a go. Warning, I'm very wordy. 
One of the biggest drawbacks of investing in certificates of deposit (CD's) is that your money is locked away in a vault and there are often severe penalties for early withdrawals. One strategy is to purchase only short-term certificates, so your money is never very far away. But short-term certificates typically offer lower interest rates, so you pay a penalty anyway. The answer? A ladder. 
You can go about setting up a ladder in a couple of ways. If you need to invest your money all at once, you use one strategy. If you invest over time, you can use a different option. I'll cover both.
Hypothetical Case 1
I have $10,000 and I want it to be tied up for no more than 3 months. I can purchase a 3 month CD and let it roll over each time it comes due or I can withdraw the money. The cost? Lower interest rate.
Intead, I will take $2500 and purchase a 1 year CD. In three months, I will take $2500 more and purchase another 1 year CD. 3 months later? Another $2500 purchase. And finally, 9 months after my first purchase I get yet another 1 year CD. Now what do I have?
I have 4 CD's each with a $2500 investment. By purchasing a 1-year certificate, I got a better interest rate. But by purchasing them over time (on 3 month intervals) I will now have at least one CD coming due every 3 months, yet at the higher one year interest rate.  Cool stuff, right? If I don't need the cash, I let the CD roll over into another 1 year term. Yet I am never more than 3 months away from getting my hands on at least 1/4 of the cash. As each initial CD is renewed, I renew for one year. By the time the process is complete, I have four one year CD's, one coming due every three months.
Hypothetical Scenario 2
I have $10,000 that needs to be invested. I purchase a $2500 one year CD, a $2500 two year CD, a $2500 three year CD, and a $2500 four year CD. Once again, I have invested in four certificates instead of just one. Once again I am buying longer-term certificates in order to lock in higher rates. The biggest differences are that I am investing the entire amount all at once, and for a longer term. In this scenario I have to wait at least a year before I can get money out. As each CD comes due, I roll it over into a four year certificate, which will finally end up with me owning four CD's each with a four year term but with expiration dates only one year apart.
This concept is called a "ladder". Next time someone talks about this idea, hopefully you'll understand what it's about. |
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| Benjamin |
| Posted: Tue Apr 12, 2005 9:04 am Post subject: |
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Administrator
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Excellent post Dave. Explained very clearly, this is very useful information!  |
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| scampf |
| Posted: Fri Mar 03, 2006 7:44 am Post subject: |
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| Thank you for the info. I may be able to repeat it to someone and pretend I have some intelligance. |
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| scampf |
| Posted: Fri Mar 03, 2006 7:45 am Post subject: |
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Investing Sr. Associate
Joined: 15 Feb 2006
Posts: 90
This Month: 0
6959.39 e$
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| That sounded bad the way that came out. I mean, It's very clear what you are saying. Thank you. |
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| DKnightSr |
| Posted: Fri Mar 03, 2006 7:51 am Post subject: |
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Member of the Month
May
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| As Dave points out, CD's roll right over. Bonds on the other hand have to roll out before they can roll back in causing delays in investment... and losses of income. I just learned THAT one the hard way! |
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