CD Ladders are Stupid

I made a mistake. I created a CD ladder.

It sounded like a good idea. CDs have high rates because the banks can hold on to your money for a longer time. By staggering your investment so that the rates average out, you can take advantage of these high returns without risking losing money on bad timing.

Ultimately, what I was trying to do was to simulate having a savings account that has interest rates as high as 5-year CDs. The difference is that a CD ladder practically guarantees a high penalty when you want to take your money out. A CD ladder consists of CDs with the highest penalties. And while a single 5-year CD would have had a small chance of maturing about when you need the money, a CD ladder never matures, ensuring that you’ll have to pay the penalties.

I’ve finally realized that there is a better way to simulate having a savings account that has interest rates as high as 5-year CDs. That is to…

Get a savings account. With interest rates as high as 5-year CDs.

Compare the highest 5-year CD rates with the highest savings account rates.

I’m not certain why these savings account rates are so high. I’m guessing that banks don’t care as much about keeping your money for a long time as they do about not having to provide expensive services around your money. Checking accounts yield low interest rates because you’re paying for the service of check processing, bill payment, ATM access, etc. The top savings accounts are no-frills. Put your money in with ACH, take it out the same way, everything’s online.

For all my fancy financial plans, it turns out that the best way to earn guaranteed interest on accessible cash is a boring old savings account. But, as with anything, it pays to shop around.

Update (Feb 27)
Am I wrong about top savings account rates following the top 5-year CD rates? Maybe they follow the top 6-month CD rates, which at the moment are just as high. I can’t find any good historic information on the top savings account rates, only averages. Or are internet-only rates too new for good historic data?

Update (July 16)
I concede defeat. Now that 6-month and 5-year CD rates have drifted apart, I can see that the top savings rates are following the 6-month CD rates, not the 5-year. The situation was a temporary aberration.

Posted by Jeremy on February 26, 2007 11 Comments.

11 Comments

  1. Jon replied:

    Your right about savings accounts providing more value right now, but that won’t always be the case. Analysts believe that the Federal Reserve will be cutting rates this year. If that happens, short-term rates, like those on savings accounts will go down. You could end up thanking yourself for locking in current rates.

    February 26th, 2007 at 7:31 pm. Permalink.

  2. Jeremy replied:

    I’d thank myself if I was buying a single 5-year CD. I have a CD ladder. My great rates will be averaged out with lousy rates from earlier years and later years. I’ll get the same effect with my savings account.

    February 26th, 2007 at 9:17 pm. Permalink.

  3. Mark A. Hershberger replied:

    Go to the branch of your local bank. Walk in and ask for a savings account. Chances are they won’t be offering anywhere close to those rates on a savings account.

    Most of those rates are online-only rates. EmigrantDirect.com started this madness a couple of years ago when they started offering 4.25% interest (they are now at 5.05%).

    The bank I opened with was UFBDirect (with a money market account now at 5.31%). UFB is based out of Indianapolis where my friend Jeff lives and when I mentioned the rate to him, he said he couldn’t see the rates. Turns out he was looking at the brick-and-morter website and they posted much, much lower rates there.

    US News and World Report wrote an article about these online-only (at least, that’s how they started) accounts.

    February 26th, 2007 at 11:28 pm. Permalink.

  4. Jeremy replied:

    I’ve been online-only since the last millennium, but my bank’s savings account rate is currently only 3.9%. They offer everything I want for an interest checking account, but I needed to go elsewhere for a high-return savings account.

    February 27th, 2007 at 8:41 am. Permalink.

  5. Chris Duncan replied:

    You seem to be missing the point of a CD vs. a Savings Account. CDs are not supposed to viewed as liquid investments. You open a CD (usually, the longer you go the higher the rate) and shouldn’t put funds in there that you may need in the future. Depending on how you ladder your CDs, you can have funds maturing every 6mos to 1yr. You are only guranteed a penalty if you don’t do some future planning. Finally, as another posted, when the Fed starts to lower the overnight rate, all savings acccount rates will fall. Right now we have an inverted yield curve, which historically points to a coming recession (ie, lower rates)

    February 27th, 2007 at 9:34 am. Permalink.

  6. Jeremy replied:

    CDs are for when you think you won’t need your money for a long time. If there is an emergency, you can still get at it with less penalty than, say, raiding your IRA. My point is that you don’t need to take that risk at all.

    You’re the second person to point out that savings account rates will fall, but you didn’t say whether you think 5-year CD rates will also fall. If the top savings rates continue to track 5-year CD rates, then while you have one fifth of your money enjoying high rates in a good CD, I’ll have all my money enjoying high rates for one year out of five. It all averages out to the same thing. Except when your emergency arises, you’ll be paying penalties.

    February 27th, 2007 at 9:57 am. Permalink.

  7. Mark A. Hershberger replied:

    Maybe you should invest in stamps.

    Seriously, though. While the Greenspan Fed operated in a certain way (raising and lowering rates quite deftly) we now have different leadership at the Fed. And reports on him aren’t as rosy as they were for Greenspan.

    Which is to say that predicting what is going to happen to rates (even with Greenspan at the helm) seems to be risky business. The Fed governs rates, true, but they’ll also take into consideration things like the effects it has on consumer debt.

    Ex: Lower rates mean increasing consumer debt … and decreased savings.

    The Fed may decide that it wants to encourage savings at the risk of a recession.

    February 27th, 2007 at 4:28 pm. Permalink.

  8. Mark A. Hershberger replied:

    oh, and I should point out that the national average for savings accounts is well below the rates that Jeremy is talking about. Which gives some meat to my claim that these rates are online-only.

    February 28th, 2007 at 11:18 am. Permalink.

  9. Chris Duncan replied:

    Sort of late for a follow-up comment, but better than never. We don’t track savings rates in our database. At the moment I have CD rates from 6M - 5Y from 1993 - 2006. These averages are much higher than national averages, but do reflect CDs that our clients invested in. The average 6M rate since 1993 is 4.367%. The average 5Y was 5.383%. Over 1% difference. So on $100,000 a 5Y ladder would have earned you around $1000 more per year. And the difference between a 5Y CD and savings account would have been much more significant. More historical CD rate information can be found at http://www.jumbocdinvestments.com/historicalcdrates.htm

    July 16th, 2007 at 11:40 am. Permalink.

  10. Jeremy replied:

    And the difference between a 5Y CD and savings account would have been much more significant.

    I think that last statement is wrong. Over the last year, I’ve been watching internet-only MMA accounts. The top ones are consistently better than the top 6 month CDs, although you may need to move your money around.

    April 10th, 2008 at 10:06 am. Permalink.

  11. Chris Duncan replied:

    As I stated, we don’t track savings rates, so it may be incorrect. However, savings accounts dropped quite substanially since the Fed began cutting rates. EmigrantDirect even lowered their rate 3-times in the same month. They stand at 2.75% instead of 5.05%. Wamu recently had a 4.25% and now sits at 3.30%. Countrywide still has a 4.05%, but for how long. Many of the higher rates are just to get your funds in the door. There is no guarantee on savings rates.

    Since rates will most likely come down further, locking them would not be a bad idea. 6-month ago, 6-month CDs were 5.35% and 1-year were 5.50%. It would seem that the people who did 1-year or longer CDs are feeling pretty good.

    Of course we don’t have a crystal ball, that is why we recommend a laddering strategy.

    Also, in regards to savings accounts vs. CDs, I was speaking historically. What has happened since 2002 or so has been history in the making.

    I can certainly look up average CD rates since then and if you want to post your average savings yields we can compare. What time frames do you want to look at?

    April 10th, 2008 at 2:13 pm. Permalink.

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