Ally Bank launched an online tool yesterday which is intended to help customers plan a CD ladder. As described at the Ally Bank blog, the tool "helps you estimate the savings created by your CD ladder by guiding you through the projected timeline of your ladder and giving step-by-step instructions for when you need to take action." I gave Ally's CD ladder tool a try, and it works well in helping you plan a basic CD ladder with Ally Bank CDs.
CD Ladders Still Make Sense?
In May I asked the question if CD ladders still made sense in today's low interest rate world. For those who responded in the poll, 42% said they are still using CD ladders. However, 22% said they have made changes to their CD ladders.
I thought it would be interesting to compare two other savings strategies with a standard CD ladder as described by Ally Bank.
Five 5-Year CDs Instead of a 5-year CD Ladder
One strategy is to just put all of your money into Ally Bank 5-year CDs. Instead of starting with a 1-, 2-, 3-, 4- and 5-year CDs, you would start with 5 equal 5-year CDs. The benefit of this is that the 5-year CDs have higher rates. So you'll maximize your returns. The downside as compared to a standard CD ladder is that you will have to worry about early withdrawal penalties at the annual intervals. As we know, the current Ally Bank EWP is small, so this can be a better deal even with the penalties.
One potential problem with using all 5-year CDs is that if you don't break the CDs early, all of them will mature at the same time in 5 years. One benefit of a CD ladder is that the CDs renew in regular intervals (like every year). That eliminates the need to guess about future rates. If rates go up, you slowly benefit with higher rates as you renew each CD.
How much more interest will you have after 10 years if you just invest in 5-year CDs instead of a CD ladder with 1-, 2-, 3-, 4- and 5-year CDs? If you assume a total $10,000 deposit and the 5-year CD rate remains the same for the next 9 years, the final balances are:
- A) Total from 5-yr CD ladder after 10 yrs: $11,737
- B) Total from 5-yr CDs after 10 yrs (early closures to mimic ladder): $11,799
- C) Total from 5-yr CDs after 10 yrs (no early closures): $11,824
As expected, the CD ladder (A) results in the smallest total due to lower rates of the short-term CDs. Using all 5-year CDs and mimicking short-term CDs by closing those 5-year CDs after 1, 2, 3 and 4 years (B) results in a slightly higher total return. Finally, using all 5-year CDs and keeping them until maturity and renewing them (C) results in the highest total return. However, the differences between these 3 strategies are not much. So if you want to keep things simple, you may want to consider a basic CD ladder.
Keeping Everything in a Savings Account
Another simple strategy is to just keep everything in a savings or money market account. This gives you maximum liquidity. It also gives you more flexibility if hot deals become available. The downside is that may result in the lowest return. If you assume today's Ally Bank savings account yield of 0.95% remains the same for the next 10 years, the total return for an initial $10,000 deposit is $10,992.
My Take on CD Ladders
It might seem unwise to renew CDs that mature today into new long-term CDs which have such low rates. However, many had those same concerns two years ago. I'm sure many readers who opened long-term CDs two years ago are glad about their choices. The problem is no one knows about how interest rates will change. The CD ladder provides a strategy that doesn't require you to guess about future rates.
CDs don't have to make up one's entire portfolio. For the fixed-income part of your portfolio that you want to keep safe, CDs and CD ladders can still make sense. For example, Allan Roth who writes for CBS News has written that he has "roughly" 70% of his "fixed-income portfolio in high-paying CDs that have easy early withdrawal penalties."
CD Ladder Overview, Strategies and Tips
We have more CD ladder info in our CD ladder overview with an infographic. There are ways you can tweak a CD ladder. I described some of these ways in my post on Alternatives to CD Ladders. There are issues that can mess up your CD ladder and reduce your CD earnings. I reviewed some of these in my posts Issues to Consider for Your CD Ladder and 10 Gotchas to Avoid for Bank CD Investors.