Laddering bonds or CDs

Laddering is a technique of holding bonds or CDs of different maturity dates in a portfolio in order to balance high yield and liquidity.

With a normal yield curve, long-dated CDs have a higher yield than shorter-dated ones. However, long-dated CDs, by definition, lock your money into an illiquid holding. A ladder provides a way to take advantage of the highest-yielding CDs while improving liquidity of (access to) your money.

Typically, you create a ladder by splitting your money into 5 parts, and purchasing CDs of 1, 2, 3, 4, and 5 year duration. When the 1 year CD matures, you use the money to purchase a new 5 year CD. After 4 years, you have all of your money invested in 5 year CDs, but 1/5th of your money is available every year. As each CD matures, you can decide whether to reinvest it in all or in part.

If you want quicker access to your money, you can also set up a 1-year ladder, with rungs at 3, 6, 9, and 12 months.

Each time a CD matures, you can purchase the highest yielding new CD you can find (known as "riding the yield curve"). In a normal yield curve, that will be the longest dated one. But in an inverted yield curve, the shortest term CD may have a higher rate. You can even chase yields by moving your money to whatever bank is offering the best rate at that moment.

Non-rolling ladder
A non-rolling ladder is a bond ladder in which bonds are not rolled over to new bonds at the prevailing rate.

Rolling ladder
In a rolling ladder, as bonds mature they are replaced with bonds of similar maturity, so that the duration of the ladder remains approximately constant. This type of ladder is essentially equivalent to a bond fund, with the added advantage that it can be converted to a non-rolling ladder at no cost by simply failing to roll over bonds as they mature.

Laddering Versus Investing in a Bond Fund
Please see Individual Bonds vs a Bond Fund for a discussion of holding a ladder of bonds vs. a bond funds.

Links

 * Investopedia: The Basics Of The Bond Ladder
 * Bankrate.com: How to ladder a CD portfolio