CD Ladder Confusion...

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Topic Author
saferthansome
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CD Ladder Confusion...

Post by saferthansome »

Hi All,

So I have finally gotten enough money saved so that I have a 6 month emergency fund in my savings account. :D

However because my income is somewhat irregular I would like to have an additional 6 months in a relatively accesible, non-volatile place. The last time I checked in here someone suggested to me that I might want to start a CD ladder for the "second" 6 month emergency fund. Since I'm relatively young (32) I feel like I can accept a little bit more risk here so I have been looking into it. Now I'm finally at the point where I could start building it. But I still don't fully understand how it works.

First, while the sensible thing would seem to be to ladder 6 month CDs (I think), that makes absolutely no sense at current rates for 6 month CDs, which are lower than the rate in my savings account. So I could do longer term CDs but there's a few things I don't quite understand and could use some help understanding...

1) How do I start? Do I have to have the full 6 months saved up in order to get going or could I do it in smaller amounts, just dividing my starting principle by 6 and investing monthly and increasing the buys as I have more money to put toward the ladder?

2) What term CDs should I be investing in? The rates are certainly better on longer term CDs... for example a 5 year CD from Barclays yields 2% interest. I was reading on the bogleheads wiki how in times of low interest the penalties are often low too... the penalty for early withdrawal at Barclays on a 5 year CD is 180 days simple interest but I don't really understand what that means.

3) Is there a simpler investment that I could make that would accomplish the goals of beating my savings account yield (currently .90%) but still being relatively accesible and non-volatile?
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ogd
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Re: CD Ladder Confusion...

Post by ogd »

I'll give my 2c, but in reverse order to your questions :)
saferthansome wrote:3) Is there a simpler investment that I could make that would accomplish the goals of beating my savings account yield (currently .90%) but still being relatively accesible and non-volatile?
Not really. Even 0.9% is a really good deal only accessible to the individual investor; the market yield on a 6 month safe investment is ~0.1%. CDs are even better.
saferthansome wrote:2) What term CDs should I be investing in? The rates are certainly better on longer term CDs... for example a 5 year CD from Barclays yields 2% interest. I was reading on the bogleheads wiki how in times of low interest the penalties are often low too... the penalty for early withdrawal at Barclays on a 5 year CD is 180 days simple interest but I don't really understand what that means.
It means that if you withdraw before 5 years, you lose 1% (6 months of interest), but no more than the interest paid to date. So it's a decent candidate for the "next 6 months", after holding it for 1 year it starts beating the savings account. If you think it's more likely than not you take it out before 1 year, you might look around for a smaller penalty (see depositaccounts.com, which also has calculations for "yield after early withdrawals after N years"). But I'd still recommend the longer term CDs since the short ones (as you note) are not worth it.
saferthansome wrote:1) How do I start? Do I have to have the full 6 months saved up in order to get going or could I do it in smaller amounts, just dividing my starting principle by 6 and investing monthly and increasing the buys as I have more money to put toward the ladder?
Since I'm recommending long term CDs, a ladder at one month granularity doesn't make a lot of sense: the purpose of ladders is to stagger maturity dates, but in your case all of them would fall within a period of 6 months, 5 years from now, and you are counting on early withdrawals rather than maturities to control term anyway. On the other hand, it might be helpful to have CDs divided up into smaller amounts so you can break just the amount you need. So I wouldn't sweat the schedule, just create a CD whenever you have a round sum available that's worth the hassle.
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Kosmo
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Re: CD Ladder Confusion...

Post by Kosmo »

If you don't understand how CDs work, don't buy them. The same goes for any type of investment. It might be easier for you to keep all the money in a savings account (and keep accumulating) until you get a better grip on how they work. But to attempt answers...
saferthansome wrote: 1) How do I start? Do I have to have the full 6 months saved up in order to get going or could I do it in smaller amounts, just dividing my starting principle by 6 and investing monthly and increasing the buys as I have more money to put toward the ladder? I'm going to skip this one for now, you need to answer #2 first to answer #1. When you decide what bank, how much money, what term, etc...it's easiest to buy them all at once. It'll be less to keep track of. If you're buying CDs of various durations when the money comes available, it's just a pain to keep track of. I wouldn't buy a CD ladder unless I had all the money readily available that I wanted to put into it.

2) What term CDs should I be investing in? The rates are certainly better on longer term CDs... for example a 5 year CD from Barclays yields 2% interest. I was reading on the bogleheads wiki how in times of low interest the penalties are often low too... the penalty for early withdrawal at Barclays on a 5 year CD is 180 days simple interest but I don't really understand what that means.The term of the CD is up to you. How often do you think you might need access to the money? Just because you have 6 months of expenses doesn't mean you have to have 6 month CDs (or 6 1mo CDs) . If you think you might need access to the money each year then use 1 year CDs. If you want to get access to the higher yielding CDs, then put 20% of you money into each of a 1yr, 2yr, 3yr, 4yr, and 5yr CD. Then each year you get 20% of your money + interest coming back and you could then buy a new 5yr CD.

3) Is there a simpler investment that I could make that would accomplish the goals of beating my savings account yield (currently .90%) but still being relatively accesible and non-volatile? Probably not.
Topic Author
saferthansome
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Re: CD Ladder Confusion...

Post by saferthansome »

Thanks for the help.
The term of the CD is up to you. How often do you think you might need access to the money? Just because you have 6 months of expenses doesn't mean you have to have 6 month CDs (or 6 1mo CDs) . If you think you might need access to the money each year then use 1 year CDs. If you want to get access to the higher yielding CDs, then put 20% of you money into each of a 1yr, 2yr, 3yr, 4yr, and 5yr CD. Then each year you get 20% of your money + interest coming back and you could then buy a new 5yr CD.
Just to clarify, the original thinking was that if I staggered CD purchases in one month amounts (with one month's worth of expenses in that CD) that each month I would have a new CD maturing that could get me through until the next month and so on and so forth.

But maybe it would be easier (as the first response noted) just to invest it in a 5 year CD and after a year it will be beating the savings account yield anyway. Plus it's not like I receive the money I'll be putting into it in monthly installments anyway..
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Langkawi
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Re: CD Ladder Confusion...

Post by Langkawi »

ogd wrote:
saferthansome wrote:the penalty for early withdrawal at Barclays on a 5 year CD is 180 days simple interest but I don't really understand what that means.
It means that if you withdraw before 5 years, you lose 1% (6 months of interest), but no more than the interest paid to date.
That is not correct. At Barclays, if the penalty exceeds the interest paid to date, they will deduct the difference from principal.
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Kevin M
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Re: CD Ladder Confusion...

Post by Kevin M »

Barclays CD is good for money you're pretty sure you will not need in at least 1 year. Another is Ally bank 5 year 1.5% CD with early withdrawal penalty of 60 Days of interest. That earns about 1.25% of you withdraw after 1 year. So a bit better than savings account with less risk then Barclays.

Ally does not allow partial withdrawals, but no need to stagger purchases, just buy multiple smaller CDs.

Kevin
If I make a calculation error, #Cruncher probably will let me know.
mikem
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Re: CD Ladder Confusion...

Post by mikem »

The Ally Bank website has a great tutorial on how to build a CD ladder including scenarios on various lengths of time and you can choose your investment amounts to see what your ladder will generate regarding returns.
HurdyGurdy
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Re: CD Ladder Confusion...

Post by HurdyGurdy »

Is there a simpler investment that I could make that would accomplish the goals of beating my savings account yield (currently .90%) but still being relatively accesible and non-volatile?
If you don't need them for a year, http://www.bogleheads.org/wiki/I_bonds . Yield wise, barely better, at least for now.
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dm200
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Re: CD Ladder Confusion...

Post by dm200 »

Also, check out credit unions as well. The equivalent of a bank CD is probably called a share certificate (or something like that). Make sure that the credit union id federally insured (all US credit unions are federally insured except for about 200 state charters in a few states). Read the "fine print" about early withdrawal penalties. Some credit unions limit the penalty to earned dividends (interest), but some can eat into the principal.
armeliusc
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Re: CD Ladder Confusion...

Post by armeliusc »

saferthansome wrote: The last time I checked in here someone suggested to me that I might want to start a CD ladder for the "second" 6 month emergency fund. Since I'm relatively young (32) I feel like I can accept a little bit more risk here so I have been looking into it. Now I'm finally at the point where I could start building it. But I still don't fully understand how it works.
I found that Ally Bank description of CD Ladder makes it easy to understand.
saferthansome wrote: 3) Is there a simpler investment that I could make that would accomplish the goals of beating my savings account yield (currently .90%) but still being relatively accesible and non-volatile?
Have you considered I-bond ? I put most of my EF in I-bond.
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alpenglow
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Re: CD Ladder Confusion...

Post by alpenglow »

I would also suggest I bonds as a second tier of your emergency fund.
Topic Author
saferthansome
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Re: CD Ladder Confusion...

Post by saferthansome »

Kevin M wrote:Barclays CD is good for money you're pretty sure you will not need in at least 1 year. Another is Ally bank 5 year 1.5% CD with early withdrawal penalty of 60 Days of interest. That earns about 1.25% of you withdraw after 1 year. So a bit better than savings account with less risk then Barclays.

Ally does not allow partial withdrawals, but no need to stagger purchases, just buy multiple smaller CDs.

Kevin
Thank you for this. And in reference to a couple of the earlier responses my mother had suggested I-Bonds as well... So if I were able to make it at at least a year (hopefully longer of course) without dipping into my secondary emergency fund then which would bring a better return, Barclays, Ally or I-Bonds? And how long would I have to keep an I-Bond before it would beat the savings account (which again is at .90%) even with the early withdrawal penalty?
mikem
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Re: CD Ladder Confusion...

Post by mikem »

I think I-bonds are currently at 0% interest with 1.18% inflation adjustment. They will announce the new rates on 10/14(I believe) so you may want to wait & see what the rates are for the next 6 months(on the inflation adjustment factor). Although, I don't think they will raise the interest rate from 0....they could.
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Kevin M
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Re: CD Ladder Confusion...

Post by Kevin M »

saferthansome wrote:
Kevin M wrote:Barclays CD is good for money you're pretty sure you will not need in at least 1 year. Another is Ally bank 5 year 1.5% CD with early withdrawal penalty of 60 Days of interest. That earns about 1.25% of you withdraw after 1 year. So a bit better than savings account with less risk then Barclays.

Ally does not allow partial withdrawals, but no need to stagger purchases, just buy multiple smaller CDs.

Kevin
Thank you for this. And in reference to a couple of the earlier responses my mother had suggested I-Bonds as well... So if I were able to make it at at least a year (hopefully longer of course) without dipping into my secondary emergency fund then which would bring a better return, Barclays, Ally or I-Bonds? And how long would I have to keep an I-Bond before it would beat the savings account (which again is at .90%) even with the early withdrawal penalty?
We don't know the break even time for I Bonds since the rate will change after six months. If you buy now, you earn 1.18% annualized for the first six months, minus the 3-month penalty if you cash out before 5 years. Clearly an Ally 5-year CD beats this over one year if you assume the same I Bond rate for the subsequent six months.

Assuming same I Bond rate for one year, your 1-year I return after penalty would be about 9/12 x 1.18% = 0.89%, so about the same as the savings account.

Since we don't know what inflation will be, why not do some of each--half in I Bonds and half in a CD or savings account? At current low rates we're talking pretty small differences no matter what you do.

Kevin
If I make a calculation error, #Cruncher probably will let me know.
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Phineas J. Whoopee
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Re: CD Ladder Confusion...

Post by Phineas J. Whoopee »

saferthansome wrote:Hi All,

So I have finally gotten enough money saved so that I have a 6 month emergency fund in my savings account. :D
...
Hi saferthansome,

My take is not so far off the others, but comes at the question from a different direction.

Although anybody can experience a total catastrophe, the reason for the 6 months of expenses guideline is to be able to last through a loss of income.

Therefore, with 6 months in a savings account, you can be without access to any additional for, well, 6 months.

If you bought a 6-month CD today and lost your job tomorrow the CD would mature just when you might need it.

If you bought I Bonds today and lost your job tomorrow you wouldn't have access to the money until 6 months too late. I Bonds are great for emergency funds, but you have to be able to see yourself over the hump - in this case, the 6 months after your savings account runs out and before the I Bonds are redeemable. You didn't speak of a Roth IRA, but you could, for example, contribute, over time, six months worth of expenses to it, keeping it in a short-term bond fund for low volatility. Because you can withdraw Roth IRA contributions at any time that would temporarily serve as your second tier. Then, you could gradually build up another 6 months worth in I Bonds, and when those start to be redeemable within 6 months change your Roth IRA investment to a better choice for the long term - possibly to begin with something like a Target Retirement or Lifestyle fund.

There are other procedures. Just remember that in the unlikely event you run through your whole savings account you'll be six months down the road, so what will you use for money at that time?

Have a plan. Don't be excessively paranoid or totally risk-averse, but have a plan to raise liquidity if you need it because of your irregular income. My thoughts might be different for somebody whose income was very reliable and stable.

PJW
Topic Author
saferthansome
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Re: CD Ladder Confusion...

Post by saferthansome »

Phineas J. Whoopee wrote:
saferthansome wrote:Hi All,

So I have finally gotten enough money saved so that I have a 6 month emergency fund in my savings account. :D
...
Hi saferthansome,

My take is not so far off the others, but comes at the question from a different direction.

Although anybody can experience a total catastrophe, the reason for the 6 months of expenses guideline is to be able to last through a loss of income.

Therefore, with 6 months in a savings account, you can be without access to any additional for, well, 6 months.

If you bought a 6-month CD today and lost your job tomorrow the CD would mature just when you might need it.

If you bought I Bonds today and lost your job tomorrow you wouldn't have access to the money until 6 months too late. I Bonds are great for emergency funds, but you have to be able to see yourself over the hump - in this case, the 6 months after your savings account runs out and before the I Bonds are redeemable. You didn't speak of a Roth IRA, but you could, for example, contribute, over time, six months worth of expenses to it, keeping it in a short-term bond fund for low volatility. Because you can withdraw Roth IRA contributions at any time that would temporarily serve as your second tier. Then, you could gradually build up another 6 months worth in I Bonds, and when those start to be redeemable within 6 months change your Roth IRA investment to a better choice for the long term - possibly to begin with something like a Target Retirement or Lifestyle fund.

There are other procedures. Just remember that in the unlikely event you run through your whole savings account you'll be six months down the road, so what will you use for money at that time?

Have a plan. Don't be excessively paranoid or totally risk-averse, but have a plan to raise liquidity if you need it because of your irregular income. My thoughts might be different for somebody whose income was very reliable and stable.

PJW
Thank you for your insight...

I've actually got about 2 years worth of living expenses in an IRA, Roth IRA, Profit Sharing Keogh and individual investment account with Fidelity. These are all purchases I made before the idea of having a 6 month emergency fund was something I was aware of (or at least took seriously). It's mostly in various total market funds (US and ex-US), a total bond fund, a TIPs fund, a REIT fund, etc. I know it's backwards from how you're supposed to do it, but it is what it is and I'm dealing with getting it all more secure now.

I think of those accounts as my retirement fund (which is funny, because I have no intention of ever retiring from what I'm doing, which is music), but in a pinch I could sell off things from that and be ok. But it would be a shame if an emergency struck during another down cycle in the market (or a total crash). Plus I'd rather not touch that stuff (other than to balance through addition). I've been putting off further additions into my investment/retirement accounts until first I got my emergency savings together and now until I get my "second" emergency fund.

But perhaps, after reading what you say I should go ahead and put the money for the second emergency fund into I Bonds or a long term CD...
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