Dear Dr. Don,
Laddering CDs has been very successful for me. About 50 percent of my assets are in CDs paying 5 percent, maturing in 2012 and 2013. Since I do not need the income to live, I prefer laddering to the barbell method. With Congress having eliminated the apprehension over raising taxes, I believe the economy will begin to thrive and savings interest rates will increase, thus favoring laddering. Your opinion would be much appreciated.
-- Richard Rungs
For readers not familiar with a CD ladder, the CD investor spreads his money across maturities, out to the longest maturity he's comfortable investing in. If the CDs are of a like size and spread evenly across the investment horizon, they look like the rungs of a ladder. The Bankrate feature "Laddering: How to build a CD ladder" is one of several on the topic. Bankrate also has a CD ladder calculator that can help you to visualize the process.
The one problem I have with laddering is that the initial construction of the ladder is often done at one point in time. The idea behind laddering is to be disciplined in investing your money. That gets you away from trying to time the market. But, if you initially put all your money to work at one point in time, you've bought in to the current interest rate environment and it's not until the rungs start maturing that you get to reinvest in a new interest rate environment.
A barbell approach has the investor keeping half his or her money in a short maturity, and half his or her money in a longer maturity. This can make sense if there's not a lot of difference in yield between maturities in these two segments of the market. Often a money market account or high-yield savings account will pay a yield equivalent to a one- or two-year CD. Why have those rungs on your ladder if you get the liquidity of an MMA without giving up any yield -- even if you don't need current income? As yields start to rise, you can migrate from the barbell to a ladder by using the money in the MMA to fund some rungs on the ladder.
I'm not lobbying for you to change your approach. It sounds like laddering has worked well for you over time. Don't tamper with success. I share your expectation that savings rates are headed higher, although I'm not sure it's related to tax certainties or economic growth. Higher Treasury yields are enough of an omen for me.
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