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Building a Ladder of Saving Certificates

Choosing the length of savings certificates is an important decision. The issues of liquidity and the future direction of interest rates can make the decision difficult. Longer maturity certificates usually provide the highest returns, but they also tie up your funds longer. Shorter maturities provide flexibility to take advantage of rising rates, but usually with lower returns. Ideally, you want the highest current return coupled with the ability to invest at higher rates if interest rates rise.

Creating a "ladder" of maturities is a way to create a "portfolio" of certificates that will put you in a position to earn good rates and invest at higher rates if interest rates rise. Simply stated, with this strategy, you divide funds into pieces and buy equal amounts of different maturity certificates.

Here is an example:

Assume you have $25,000 and want to buy certificates with maturities up to five years. The rates on certificates are:

1 year0.60%
2 year1.70%
3 year2.15%
4 year2.50%
5 year2.95%

By making initial purchases of $5,000 each of the different maturities, your average rate is about 1.95 percent. Each year, as a certificate matures, use the proceeds to buy a five-year certificate. That way, over time, more and more of your funds earn the highest rate and you still have annual liquidity. If rates rise, you have liquidity to buy higher-yielding certificates. If rates fall, you are still earning high rates on your existing positions.

No one can accurately predict the future of interest rates. Using this "Ladder of Maturities" strategy can help position you to benefit regardless of the direction of interest rate changes.

This content has been provided by Practical Money Skills and is intended to serve as a general guideline.