Make your money work for you by ‘laddering' bonds or CDs

CNN

a day ago

If you have a lot of cash on hand, it should be making money for you.
One way to ensure it continuously does that is to set up a ladder of Treasuries or FDIC-insured certificates of deposit with staggered maturities (eg, 1 year, 2 years, 3 years, etc.).
A laddering strategy can offer low-risk, predictable returns that will help you keep up with — or beat — inflation, while protecting your money during volatile markets and helping you meet your near- and intermediate-term goals.
'Which ladder works for you depends on your needs,' said Collin Martin, a fixed income strategist at Schwab Center for Financial Research.
For example, ladders can be useful if you want to:
Preserve purchasing power: A fixed income ladder can help if your main concern for a given sum of money is to protect the principal and not let inflation devalue it.
Rhode-Island based certified financial planner Sue Gardiner had a client whose goal was to preserve capital and protect purchasing power of money going to beneficiaries of an inherited IRA that had to be fully distributed within 10 years.
'So we used TIPS (Treasury Inflation-Protected Securities) to hedge inflation, but balanced them with Treasuries and brokered CDs to lock in competitive yields and keep annual liquidity,' she said. 'The ladder was designed so each year's withdrawal is funded by maturing securities.'
Pay off debt: If you have credit card debt and can secure a zero-rate balance transfer card — which lets you pay off your debt interest free for up to 21 months — a ladder of CDs or bonds can generate additional income to help clear your balance.
Say you have $100,000 from the sale of a house or an inheritance. If you don't already have an emergency fund, set aside some of the money into a high-yield FDIC-insured online savings account or a money market fund. Then split the rest evenly across the number of 'rungs' in the ladder you choose. For instance, a three-month CD or Treasury, another one maturing in six months and a third one maturing in a year.
As a CD or Treasury comes due, direct the income it throws off plus some or all of the principal to pay down your 0% credit card debt, Gardiner suggested.
Grow savings for a specific end date: Or, say you want to have enough money to make a down payment on a home in five years. 'If the goal has a finite date, ladder the strategy so all the money is available for the down payment [on that date],' Gardiner said.
Set up a cash flow stream: If you're about to retire but won't claim Social Security for a few years, you might consider a laddered bonds strategy to provide a steady income stream between now and then or even for longer.
'It provides stability and predictability while bridging the gap until larger income sources like Social Security kick in, or to create a predictable foundation while other assets are positioned for growth,' Wade Pfau, founder of the site Retirement Researcher, wrote in an article about bond laddering. 'As one (bond) matures, the principal is returned and can be reinvested or spent, depending on your needs at that time.'
To set up a laddering strategy that works for you, consider these questions:
How long before I need the money? Be very clear what your liquidity needs will be for the money you're investing.
Once a ladder of investments with staggering maturities is set up, if you tap any before they come due, you may have to pay a penalty in the case of CDs that you buy directly from a bank; or you might lose some of your principal if you're selling a bond (or a CD purchased through a brokerage) when you sell it back into the secondary market.
'Make sure you match up maturities of those holdings with what your time horizon is. You don't want to suddenly need all of it and be forced to sell at a loss,' Martin said.
Also know that any investment on your ladder that is labeled 'callable' means the issuer can recall it and pay you back your principal before the instrument comes due, plus any income owed up until that point. So ideally, you will only invest in non-callable CDs or bonds, otherwise you might need to reinvest it sooner than you think.
Does it make more sense to invest in CDs or bonds? What you'll net after taxes from your investment is a key consideration. The income you earn from a CD is taxable at the federal, state and local level. If you invest in Treasuries, the income is exempt from state and local taxes. So if you live in a high-tax area, they may be a better bet. But if you live in a state with no income tax or very low income taxes and the yield on a CD is better than a bond of similar duration, the CD may be your better bet.
Do I want to manage the ladder myself? If you're setting up a ladder of CDs or Treasuries for a one-time, date-certain purpose and your plan is to use the money as it comes due, that might be the simplest thing for you to set up and manage.
But if your plan is to use a ladder on an ongoing basis for income, that will mean you have to keep track of everything and be proactive about reinvesting your money whenever it comes due to maximize your income potential. Alternatively, there are now some ETFs that ladder bonds, which can do the work for you if they're structured in a way that meets your goals.
If you're building you own ladder, your brokerage may offer model laddering strategies that will help you set one up and then can automatically do the reinvesting for you if you choose.
If, however, you're considering laddering municipal bonds for their tax advantages or corporate bonds to maximize yield, you might consult a fixed income adviser or have an investment professional manage your ladder for you because those instruments require a little more research to make sure you're getting the risk-reward trade-off.
'You don't want to blindly invest in those,' Martin said.