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Tuesday, October 9, 2012

Visualizing the Impact of C.D. Laddering


With interest rates on savings accounts still anemic, considering a so-called ladder of certificate of deposits might make sense. Ally Bank has started an online tool with interactive graphics that helps savers visualize the laddering process and its potential financial benefits.

Say you have a lump of cash that you've saved, perhaps $50,000 for an emergency fund, and you want to keep it in a low-risk, F.D.I.C. insured account. But you also want to maximize your interest rate, and you don't want to risk having to pay a fat penalty if you need some of your money.

Instead of putting the entire amount in a one-year C.D., you might divide the amount into five equal pots of $10,000 each and put it into sepa rate, progressively longer-term certificates. The first pot goes into a one year C.D., the second into a two-year C.D., the third into a three-year and so on. (Longer-term certificates generally carry higher interest rates.)

When the one-year C.D. comes due, you roll it into a five-year C.D. (or whatever the longest term is that you've bought already). After five years, all the C.D.s will be for the same term, but you'll have access to at least part of your money every 12 months.

With Ally's tool, you enter the amount you have to deposit, and the tool walks you through the process of laddering. One drawback is that the tool uses Ally's current (albeit competitive) interest rates (1.04 percent annual percentage yield on a one-year C.D and 1.69 percent A.P.Y. on a five-year C.D.). You can't plug in rates you find elsewhere. But the tool does help you to clearly see the impact of laddering. You could print out your example and go compari son shopping.

For example, the tool calculates that if you have $50,000 to deposit over five years, using the bank's current rates, you'll come out an estimated $1,600 ahead by laddering than if you simply put the money in a one-year C.D. and renew it annually. (The example assumes, however, that the rates on the C.D.'s stay the same as you renew). The impact is less striking over a shorter period, because the rates on the C.D.'s are lower; the difference for a three-year laddering plan using $30,000, for instance, is an estimated $610.

Do you think laddering C.D.'s makes sense?