When you’re young, you spend time accumulating wealth. When you’re old, you should spend time protecting wealth.
Multi-millionaires go broke all the time because they exposed themselves to too much risk and temptation. Think about all those pro athletes who would still be rich if they had just kept all their money in a bank.
Since 2010, money market and CD rates have been particularly horrible. Retirees depending on fixed income were forced to take more risk. And thankfully, such risk has paid off as the S&P 500 and the real estate market across various parts of the country took off. Further, we’ve all been able to refinance our mortgages at rock bottom rates.
But now, rates are finally moving up given the Federal Reserve has raised their Fed Funds rate multiple times since 2015. No longer do you have to lock in a CD for five years to get only a 2% rate. No longer are you only getting 0.1% on your money market account either. Remember those dog days? You can now get a 12-month CD paying 2.5% or a money market account that pays 1.85%.
With a 12-month CD rate paying 2.5%, you’d think that you could get a much higher rate if you decide to lock up your money for longer. Unfortunately, the best rate for a 5-year CD is currently about 3% in 2018, hardly high enough to lose four more years of liquidity.
As a result of a flattening yield curve, financially savvy individuals should optimize their cash and build a CD Step Stool and NOT a CD ladder. The first step is a one-year CD and the second step is a two-year CD at most. With each expiration of the CD, the strategy is to re-invest the proceeds in another 12 – 24 month CD. Only if the yield curve steepens should you consider building a CD ladder where you’re investing in three, four, five, seven, and 10 year CDs.
Let’s look at various financial scenarios where building a CD Step Stool may or may not make sense.