Dear Dr. Don,

Would it be better to have a 10-step ladder instead of a five-step ladder when investing in CDs? Instead of investing $20,000 once a year in a five-year CD, would investing half that amount every six months in a five-year CD enable you to get a better return on your money since interest rates fluctuate so much over time? — Richard Returns

Dear Richard,

When you construct a laddered certificate of deposit, or CD, portfolio, you put money in equal installments out to a maximum-investment horizon, in your case five years, like rungs on a ladder. As a rung matures, assuming you don’t need the proceeds to fund current expenses, you reinvest the maturing CD out to your investment horizon.

Having the rungs of your CD ladder mature every six months, instead of every year, makes your CD portfolio somewhat more responsive to a changing interest rate environment. That’s because you are reinvesting every six months instead of once a year. It’s an advantage in a market where rates are trending higher and, conversely, a disadvantage as interest rates trend lower. You may also struggle to find 4.5-year CD or other odd maturities when initially building your ladder.

Laddering a CD portfolio has been compared to dollar-cost averaging an investment in stocks. Both approaches allow investors to earn an average return on an investment by not trying to time the market. An important difference is that with a laddered-CD portfolio, a sum of money is invested upfront, and then parts are reinvested as CDs mature. Dollar-cost averaging into a stock position has the investor buying the same dollar amount of the stock on a regular basis with the number of shares purchased varying based on the then-current stock price.

It’s the discipline in reinvesting the money that moves the CD investor away from trying to time the market, but if the money is initially invested at one point in time, the laddered-CD investor’s initial returns are based on the yields available at that point.

In today’s interest rate environment, with a small spread between short-term CD rates and longer-term rates, it can make sense to start with a stepladder and move to an extension ladder as the spread between short-term CD rates and long-term CD rates widens. Although it seems counterintuitive to try to avoid timing the market by timing the market, the idea is to not let the rate environment at one point in time dominate the return that you will earn on this investment approach.

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