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Can You Earn More With a Fidelity CD Ladder?

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It’s been a long time since banks offered savings accounts with decent returns. The Fed may raise interest this year, meaning rates could finally rise. In the meantime, what do you do?

If you’re looking for a quick way to create an investment vehicle that is FDIC insured, and promises greater returns than online savings, Fidelity Investments has an option for you. The new Model CD Ladder tool is Fidelity’s attempt at bringing easy CD Ladders to its account holders. Let’s look at what this tool offers and see if it’s a better option than an online savings account.

Finding a Safe and Steady Return on Cash Holdings

For a detailed explanation of CDs, go here. Basically, in a volatile financial environment, CDs offer investors an FDIC-insured means to safely earn a consistent return on their cash. The rates of return can’t match the stock market, but they are better than what you’ll find with savings accounts. If the Fed finally decides to raise interest rates, the yield on new CDs should rise with them.

CD Ladders Explained

CD Ladders are multiple CDs purchased together, each with varying time horizons. This “ladder” is designed to return the owner’s initial investment at intervals, with interest payments paid out during the life of each individual CD. Each CD is a different “rung” on the ladder. As each CD matures and you climb up the ladder, your yield rises and liquidity remains the same. The goal is to max out the ladder with the highest yielding, longest term CDs and continually renew them as each rung expires. Your waiting time for each rung to mature should be the same as the very first CD that matured.

Yield, Liquidity, and the World of CDs

I just mentioned yield and liquidity. I want to find an equilibrium between the two when I am building my CD Ladder.

Yield is the rate of return that I’ll receive on my premium. My premium is my initial investment in each CD, and in Fidelity’s case, $1,000 is the smallest CD they broker. I’ll address overall minimum investment amounts later.

Liquidity is how easily or quickly I can access my investment.

Liquidity and yield are inversely related in the world of CDs. As liquidity rises, yield falls. As yield rises, liquidity falls. This is true when you first purchase the CD. Rates are generally locked in upon purchase.

But I said that “your yield rises and liquidity remains the same” when you create a CD Ladder. This is true, and you’ll understand why by the end of this article.

Put another way, the longer your CD time horizon, the less liquid it will be. It will take me more time to access the money I’ve invested, usually measured in months and years. If I have a 5-year CD, I’ll have to wait 5 years from the date of purchase to access the principal. If I want to access it before the 5-year period is up, there will be a penalty fee associated with that action. There is, however, a bonus to having to wait so long to get my premium back. Because of the inverse relationship of yield and liquidity, though, your yield is going to be higher. Ideally it’s high enough to make it worth waiting 5 years!

Conversely, the short time horizon CDs – such as 3 to 12 month CDs – are more liquid and yield much less than a 2 to 5-year CD.

In my ladder, I would start out with low yielding, shorter term CDs. They will mature in the first two years, while the clock ticks away on longer term, less liquid CDs with a higher yield. By doing this I am balancing my need for liquidity and yield with a mix of short and long term CDs.

Once I make it past the initial CD, or rung, my average percentage yield (APY) climbs with each rung expiration. That is why the CD ladder is a great tool for holding cash.

Fidelity’s New CD Ladder Tool

Fidelity Investments new CD Ladder tool lets you quickly make a CD Ladder that meets your individual yield and liquidity goals. Divided into three easy steps, your Model CD Ladder can become a reality in just a few minutes.

When creating your CDs with the Model CD Ladder tool, you will pick between a 1, 2, or 5-year ladder. Let’s look at what it takes to create each one, and what kind of return you can expect.

Minimum Amounts and Yields

If I want to create a Fidelity CD Ladder, it will take $4,000 or more. The next minimum investment amount is $8,000 (you calculate by $4,000 increments). Also, the $4,000 minimum applies to the 1- and 2-year ladders, and a $5,000 minimum applies to the 5-year model.

If I’m going to create a 5-year CD Ladder, I’ll need the $5,000 minimum and increase that by $5,000 increments if I want to invest more.

The yield for each ladder varies day-to-day, but as of this writing you’re going to see the following:
cd
Time Horizons

I can choose between a 1-year, 2-year, and 5-year CD Ladder.

The 1 year option will consist of 4 CDs that mature at the 3, 6, 9, and 12-month maturity date. For example, if I buy a ladder on November 1, the first portion (3 months) of the ladder will mature on or around February 1. This specific CD will pay both the interest accrual and full principal upon maturity. At 3 months, the amount will be relatively small. The 6-month CD will mature on May 1, the 9-month on August 1, and the 12-month on November 1 of the following year. Here’s an example of a 1-year Model CD Ladder:
cd1
The 2-year ladder will hold 6, 12, 18, and 24-month maturity dates. The same example above will apply with the modified time horizons. I will receive the original principal as each rung expires, and interest payments for the life of each CD. Here’s an example:
cd2
The 5-year ladder will hold CDs with 1, 2, 3, 4, and 5-year maturity dates. Remember, I needed a $5,000 minimum investment to start this longer-term ladder. This means I’ll get 5 annual principal payments and interest payments throughout each year. Here’s the 5-year ladder example:

cd3
*Assumes that I reinvested each premium into the longest term, highest yielding CD after the first CD expired. For the 1-year CD Ladder, I’d purchase another 12-month, 0.80% yield CD. For the 2-year ladder, I’d buy the 24-month CD yielding 1.20%. The APY listed in each chart is the starting APY, and this climbs as you reinvest each rung.

Using the 5-year model as an example, I should re-invest the principal from the 1-year CD into the ladder when it matures. I’ll then buy a 5-year CD to add another rung and keep the ladder going. This will cause my average percentage yield to climb. Consider that I would add a 1.80% yielding CD – or higher if interest rates rise – and eliminate that short term low yielding CD by letting it mature. My 2-year CD is now only 1 year from maturity and yielding 1.25%, and so on. At the end of the 5-year period, I’d have a CD ladder with a 1.80% APY.

This is the power of the ladder. If I do nothing and take the principal out as each rung expires, I am losing out on future higher returns.

Author’s note: I used this CD Ladder calculator to do the calculations for these examples. This website has over 400 financial calculators for personal finance, business analysis, and more.

Ladder Strategies: Investment or Income

After choosing the time horizon for my ladder, I must decide between two strategies to achieve my goals. Do I want to just contribute an initial investment, or do I have a specific annual income that I’m after?

With either option, the job is easy. If I desire $100 in annual income from a CD ladder, I see I’ll need to invest $10,000 in a 5-year ladder. Fidelity automatically fills the ladder with the best CDs that match my strategy. This is true whether I’m using either strategy.

Overview and Estimated Interest

The overview tab lists out the key details for each rung of the ladder. The coupon rate (yield) and maturity date are available for the user to see immediately on each rung.

The estimated interest tab breaks down the payment schedule for the ladder. A key point to note here is that it does not illustrate the power of executing the ladder. The chart does not assume you reinvested the principal each time a rung expired.

Choosing CDs and Attributes

If I want the freedom to pick and choose CDs, I’ve got it. I can replace any rung in my ladder by choosing other CDs on the market.

All CDs will tell me if they have sinking fund protection, call protection, and FDIC insurance. I have yet to see one that didn’t have those three options.

If I click on the CD name, I’ll get the Overview and Price/Performance tabs where I can get the CUSIP, Issuer Information, and see how often the CD pays out interest.

Other Options – Custom Rungs

There is an option to select different bond types and ratings. Don’t mess with it. The Fidelity Model system operates on the same page as their bond ladder program. By selecting your model CD Ladder, you’ve already notified the system you want to see CDs and there are no additional settings you should adjust here.

There is a custom “number of rungs” option, and after experimenting with the tool I could modify the ladder to between 2 and 5 rungs.

No Fees and Renewal Options

Fidelity charges no fees for buying CDs using their ladder tool. There are no annual cost or commission fees.

Fidelity will not automatically renew your CDs for you, so it’s important to track when your CDs are maturing. Reinvest the principal of your maturing CD into the longest term, highest yielding CD available for your ladder.

A Word on Penalty Fees

If I create a CD Ladder, and an emergency – or opportunity – pops up that requires me to cancel one or all my CDs, what will happen? Many investors assume they will automatically face an early withdrawal penalty. This isn’t the case with Fidelity’s CDs.

Since I’m creating my ladder out of brokered CDs, there are no termination penalties brought on by Fidelity. If I do want to exit my CDs, I must find a buyer for each one to get my principal back. The CD will be sold on the open market to other individual or institutional investors, so I may not get the full-face value when I sell. This is a slightly better option than facing steep fees associated with canceling some types of non-brokered CDs.

This is a factor you’ll have to weigh when deciding whether to start CD Ladder. If you have extra money sitting around that is not “working” for you, I’d seriously consider a 2 or 5-year ladder.

But what about Online Savings Accounts? Don’t they provide a decent yield with great liquidity?

Well, sort of. There is no debate as to the liquidity of a savings account compared to a CD. But I’ll bet your online savings account won’t be able to beat the yield of a CD over longer time horizons.

The best online savings accounts will yield about 1 percent. That is better than most brick and mortar savings accounts. But I must consider how often and in what circumstances I’ll use the cash I have put away in my savings accounts. I will not use my emergency fund for anything other than an emergency, which statistically does not happen often in my life. My personal earnings are sufficient to cover most unexpected expenses with the help of a credit card, if necessary.

If I am going to hold large amounts of cash outside of what I need for my emergency fund, I should consider using a CD Ladder. That way, I can increase my returns and at least maintain pace with inflation.

Online savings accounts can be beat within one year of starting a Fidelity Model CD Ladder.

Right now, a 1-year ladder will never match the online savings account.

But, if I use the 2-year ladder, I will beat online savings accounts by the 12-month mark! Boom. Every 6 months, I’ll have $1,000 due to me that I can either use or reinvest back into the ladder and earn 1.25%. If interest rates rise during the life of this ladder, the longest I’ll have to wait is 6 months before I can purchase a new rung with a higher interest rate. Here’s how the math works out:

cd4

For a 5-year ladder, Fidelity beats the best online savings accounts immediately. The only disadvantage it has against the 2-year model is the liquidity. I’ll have to wait 12-months for each rung to mature, rather than 6-months with the 2-year model.
cd5

The Evidence Favors the Ladder

If you agree that you generally don’t access your cash stockpiles in your online savings accounts, the evidence favors using a CD Ladder. It doesn’t have to be from Fidelity, but this tool illustrates that you can quickly outpace the returns of the latest 1% online savings account. I wish my bank offered this tool and the great rates that come with it. Right now, I’m only seeing a CD for 1% at my home bank.

Fidelity CDs vs Ally Bank and Others

In the 5-year CD Ladder, Fidelity beats Ally Bank on a $5,000 investment by 10-20 basis points. Ally has a 3 and 4-year Ladder option that beats the Fidelity 2-year model. Fidelity also sells 3-year CDs that yield just 5 basis points lower than Ally’s 3-year term. You can use the model tool to insert a CD like this into your custom ladder.

Nationwide Bank offers more competitive interest rates than Fidelity. The 5-year yield is around 2.25%, which over the first 5 years of a ladder will earn you about $120 more than Fidelity’s model.

Discover Bank is about the same as Fidelity for anything 5 years or less. It’s the same with Alliant Credit Union.

Fidelity beats Capital One by half a percent on a 5-year CD, and beats all other time horizons.

What Works for You

Fidelity’s Model CD Ladder tool makes it fast, simple, and easy to start earning more on your cash. If you don’t have any fixed income vehicles in your asset allocation plan, this may be the perfect place to get started. Balance your liquidity and yield needs to come up with the perfect ladder, either by choosing a target annual income or initial lump sum investment. Online tools like this are perfect for experimenting – use it to find the right CD Ladder for your investment strategy.

Have you ever tried a CD ladder?

Published or updated November 25, 2016.

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