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Is now the time to lengthen your CD ladder?

Nothing is written in stone, but a fair number of pundits are hazarding a guess that the Federal Reserve is done raising rates, at least for a while. If they're correct, then this might be the best time to build a certificate of deposit ladder.

The rationale is that although short-term rates may still rise, especially in markets where there's strong competition for deposits among banks, the major force driving them the past three years is gone.

For quite some time, yields on shorter-term CDs with maturities of three months to one year have outpaced five-year CDs and, because of that, many investors built ladders consisting of short-term maturities. No one wanted to lock in a rate that would look low a month later when another rate hike was announced.

CD laddering is a tried-and-true way to create a steady stream of money available at regular intervals. It also allows you to take advantage of interest rates across multiple maturities and to even out peaks and valleys in interest rates.

People who hold true to a typical CD ladder formula will build a five-year ladder and stick with it through low rates and high rates. But that requires the iron-clad discipline of Superman, and not everyone has that.

Psychologically, it could have been very difficult for someone to buy a five-year CD in January 2006 that was paying 3.9 percent when the one-year was paying 3.31 percent. It didn't seem worth locking up money for an additional four years to gain little more than a half-percent annually. So, people built ladders that stretched out only a year with, perhaps, four rungs: three months, six months, nine months and one year.

But if 5.5 percent is the best we can expect for a five-year CD, then we should consider building out the ladder farther. 

Time to lock?
The question each investor has to answer is: How long to wait before locking in a rate? Just as with the stock market, greed can hurt you. Wait until there are clear signs, and rates on the short end might already have started dropping. But if you don't wait, you may lock in long rates and then find they still have room to grow.

That may seem like a lot to concern yourself with. Truth be told, it's probably not necessary to worry about it. The most important thing is getting the ladder started.

"With a flat yield curve and very attractive short-term rates, build the short end of the ladder first, and if you don't have enough money to build out four and five years, wait to put them into place," says Barry Vosler, Certified Financial Planner at Linsco/Private Ledger in DeWitt, Iowa.

Next: "Your ladder doesn't have to be CDs."
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1 yr CD 1.01%
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