Cash Management: CD Laddering

Effective cash management is critical for you to preserve liquidity, collect interest, and acquire assets that compound wealth. The certificate of deposit (CD) is a tool integral to cash management. Conservative savers may implement CD laddering strategies to mitigate interest rate and inflationary risks.

Bank Deposits and FDIC Insurance

A certificate of deposit is effectively a loan made out to the bank. CD holders collect interest payments until the principal balance is repaid at maturity. Here, lengthier maturities typically offer higher interest rates. Be further advised that you will be charged penalties for closing out the CD before its maturity date. The Bank profits on “the spread,” or difference between interest received and paid out on deposits.

As banking deposits, both CD principal and accrued interest are guaranteed by FDIC insurance. For 2022, the FDIC insures $250,000 worth of deposits per customer, per bank. Wealthy depositors may take out CDs at multiple banks – for more coverage.

CD Interest Rates

The Federal Reserve Act of 1913 awarded the central bank with the contradictory dual mandate of full employment and a stable price level. Fed Chair Jerome Powell has already signaled his intent to aggressively hike interest rates, in response to persistent 9% inflation. The Fed targets higher interest rates to discourage speculation, slow the economy, and lower prices. We forecast recession.

The federal funds rate is now 2.5%. From here, Wall Street expects the Fed to hike this benchmark, overnight lending rate by another 75 basis points at its next September 20 meeting. Bank deposits have responded in kind, with one-year and five-year CDs now paying out 2.75% and 3.25%, respectively.

CD Laddering

Proper CD laddering strategy calls for you to take out CDs with different maturity dates to game the yield curve. A simple CD portfolio may include two separate one-month and one-year CDs. The short-term CD provides cash each month that can provide immediate liquidity to be reinvested at higher rates. Meanwhile, the long-term CD would lock in a good rate, if interest rates were to actually fall in the future.