Laddering in a low-rate environment
By Laura Bruce • Bankrate.com

Laddering fixed income products, such as certificates of deposit and bonds, is a good way to lessen your exposure to interest rate fluctuations. If your ladder stretches out over five years, you'll generally see a significant difference in the spread between the short-term rates and the longer-term rates.

As investments on the shorter end of the ladder mature, the cash is reinvested at the longer end, where, presumably, the rates are considerably higher.

But in a prolonged low-rate environment where five-year returns look more like decent three-month returns, it can seem hardly worthwhile to maintain a traditional ladder. The current average yield for a five-year CD, according to Bankrate surveys, is 2.17 percent. In January 2008, the average yield for three-month CDs was 3 percent.

Shorten the ladder?
One solution might be to shorten the ladder, a move some financial planners don't favor because they believe in staying the course in good times and bad. But others say that if you stick with a three- or five-year ladder you'll be stuck with a long-term CD that's paying below market returns when rates finally turn upward.

"I'm looking at some online banking Web sites and I see a six-month CD at 1.25 percent, a 12-month at 1.5 percent, and a 48-month and a 60-month at 1.75 percent," says Deana Arnett, Certified Financial Planner at Financial Planning Services Inc., in Manassas, Va. "I hope people aren't taking advantage of those rates. I would bet that five years from today the person who bought that 60-month CD at 1.75 percent has either surrendered it early and taken the penalty, or they've let it sit and they're sorry they bought it."

Arnett says that if the money absolutely can't be exposed to market risk she looks for the best six- and nine-month CDs she can get.

"It's very difficult at this stage to make a compelling case for laddering any type of fixed instrument on more than a one-year basis. Even a year from now I believe that rates will be higher than they are today," Arnett says.

Bond exposure
Jason Flurry, CFP and president of Legacy Partners Financial Group, in Woodstock, Ga., says his company is keeping ladders to one year or less but is adding a little bit of corporate bond exposure to the mix.

"Just like stocks, bonds have been beaten down as a result of everything we've been through," says Flurry. "A company that may have been AA rated before is now BBB. In some cases these are just guilty by association. We're being very careful but we're looking at banks and financial institutions that have received TARP (Troubled Asset Relief Program) money. We're holding some AIG bonds -- American General Finance income notes -- AIG's life insurance business. I don't have the courage to go out more than three or four months, but we're looking at anywhere from 15 percent to 19 percent yield-to-maturity between now and Sept. 1. They've made such a poster child out of AIG that I don't think the government can afford to let it fail."

If a company hasn't received TARP funding -- in other words it's not too big to fail -- Flurry expects a minimum credit rating of BBB. But he's not taking a risk with GM.

"I've passed on Chrysler, too," he says. "[If a company is] going through bankruptcy, you're really at the bottom of the food chain when it comes to getting [your investment] back. When they restructure debt, the common shareholders are the people with the least amount of clout and the unsecured bondholders are right ahead of them. They can cut you off in a hurry. You may have a great yield, but you don't get your principal back."

If you want to add risk to your portfolio to get a higher yield, Flurry advises keeping the ladder very short in those situations and mixing in plenty of conservative investments such as CDs.

"We would have AIG come due in September and then we might have a CD come in behind that in November and then another one of these notes coming due in December and something else in January. That's for a couple reasons; we expect rates to go up in the next 12 months, whether it's inflation or deflation, and we want to capture as much yield as we can and stay as conservative as we can."

If eating higher up on the food chain is more appealing to you, Flurry says he's found AA-rated bonds such as GE paying upward of 9 percent. He also points out that A-rated companies such as Genworth Financial, TransAmerica and Lincoln National have bonds with yields of 7 percent or better and maturities of three to five years.

Keep in mind that bonds can be complicated, and professionals such as Flurry spend a great deal of time analyzing bonds before purchasing. If you're not well-versed in bond analysis, it may be worth your time and money to let a professional make the selections.