Laddering versus Chunking

Many times clients come to us to find a better rate than what their bank is offering when a CD is coming due.  Sometimes they are looking for the best short term rate because they fear interest rates are going up and want to have the money available sooner rather than later.  Other times they are willing to look at a longer term rate such as five years.

We recently ran some calculations for a client based upon these very scenarios comparing a two to five year CD / fixed rate ladder to chunking into a two year or five year CD / fixed rate annuity or bonds.  We compared what happens when interest rates increase, decrease or stay the same.

If we believe interest rates are going down or staying the same we will generally want to find the best rates available to us.  The only concern is getting access to the funds when we need them.  CD’s and fixed rate annuities provide access to principal when they mature.  CD’s typically allow access to the interest they pay and fixed rate annuities typically allow withdrawals of up to 10% per year.

The instances where someone would not want to chunk into the highest interest rate they can find are when they need more than 10% per year from the annuities or the interest available from the CD’s or bonds before maturity or if they are concerned about rising interest rates.

If we are concerned about rising interest rates, laddering a CD / fixed rate portfolio is a great alternative.  Laddering is also beneficial to be able to maximize FDIC coverage for CD’s and state insurance protection in the case of annuities.  As many are aware, FDIC insurance only covers $250,000 per person, per bank.  What others may not be aware of is that many states such as Tennessee and Georgia  also cover annuity contracts up to $250,000 and $100,000 respectively for each individual.


A CD / fixed rate ladder is a portfolio of CD / fixed rates with maturity dates that are evenly staggered so that a constant proportion of the CD / fixed rates can be redeemed at maturity each year.  By holding these to maturity, investors may minimize the potential for losses caused by interest rate fluctuations and the markets.  Generally speaking, there are two broad types of CD / fixed rate ladders. One can be implemented more or less perpetually for trusts, endowments, and other applications with extended planning horizons. Another form of CD / fixed rate ladder can be implemented for individuals whose personal financial plans might have a definite endpoint in mind.

Building a ladder provides some certainty, because investors know how much they will earn if they hold to maturity.  Laddering is a strategy where investors purchase CD’s and fixed annuities with staggered maturity dates to maximize yield while maintaining scheduled liquidity.  When short term CD’s from the low rungs of the ladder mature, the funds are reinvested at the top end of the ladder. As interest rates rise, investors may be able to increase their cash flow by seeking higher yields in longer maturities.

Below is a video explaining this process and an example:

In the wake of the recent economic and market woes, many have repositioned their portfolios into cash equivalents. Certainly this strategy has potential benefits such as preservation of capital, but it also has downsides such as lower potential yields, under pacing of inflation, and limited FDIC coverage. The use of laddered Certificates of Deposits and fixed annuities can be utilized to partially overcome these yield, inflation, and insurance concerns.

Being that longer maturity CD’s and fixed annuities generally have higher yields, staggering the maturity dates provides usually provides a higher overall yield than purchasing one CD every 6 months to two years. (Although relatively rare, a yield curve inversion could potentially cause shorter maturities to have higher yields.) Additionally, with a CD maturing every year, a regular cash influx is created so that investors can potentially capitalize on any new investment opportunities.

Below are links pertaining to FDIC coverage to bank deposits as well as state protections available on insurance products.

Data as of 6/10/2016

Joe D. Franklin, CFP is Founder and President of Franklin Wealth Management, a registered investment advisory firm in Hixson, Tennessee. A 20+year industry veteran, he contributes guest articles for Money Magazine and authors the Franklin Backstage Pass blog.  Joe has also been featured in the Wall Street Journal, Kiplinger’s Magazine, USA Today and other publications.

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