Effective ways to create a laddered CD portfolio

Certificates of Deposits or CD’s are a very popular mode of investment with most investors. These are similar to bonds in many ways and have a few distinct advantages over the rest of the fixed income instruments. There is only one structural difference between the CD and a bond which is the interest that is paid at the time of maturity as opposed to being paid an interest periodically. However, there are other differences to bear in mind such as the fact that the interest earned on the CDs is fully taxable. CDs are covered by the FDIC insurance and are available only through the banks.

Laddered CD portfolios are a very common practice among investors. Laddering offers a highly customized and safe way of producing cash flow. It is fairly simple to set up a laddered CD portfolio. This basically involves spreading the investment over multiple CDs with different maturity dates. The main aim is to create a portfolio which can produce cash as well as interest to suit your financial needs at periodic intervals.

For instance you could invest around $10,000 spread over 10 CDs and create cash flows every quarter, for the next two and a half years where there would be one $1,000 CD that would mature every quarter. As and when the CDs mature you will simply have to reinvest the original amount into fresh investments to continue with the quarterly cash flows. Or, in other words, the laddered CDs need monitoring on a fairly regular basis. However, this process can be more structured by getting your banker to renew your CDs.

Benefits of laddered CD portfolios

Laddering CDs could be very beneficial to investors. Investors will be able to customize the interest as well as the cash flows. For instance, there may be someone who wants a monthly interest out of the payments and there may be the others who would need the cash just once a year.

CDs are also safer options as they are covered by the FDIC insurance against default and the investor is safe even if the bank becomes insolvent. The US treasury bonds are the only exception where there is backing by the federal government. Such protection is not offered to any other fixed income investors.

The other benefit of laddering CDs is that the investors would be able to customize their total or aggregate rate of interest, which is normally on the upside.

For instance, an investor may purchases only the 3-month CDs to generate quarterly cash flows thereby realizing a low rate of return. With the laddering of the CDs they can still receive quarterly payments but with a total portfolio rate of return that is much higher as longer maturity CDs usually pay a higher rate of interest.

Brokerage houses

CDs can be purchased directly from the banks and don’t carry any commissions. Investors use brokerage houses to save time instead of searching from bank to bank in order to get the best CDs. These houses only broker the CD and don’t issue them.