Climbing the ladder

I enjoy reading Entrepreneur and save every issue. The magazine is often filled with great advice. However, I found an exception in the September 2004 issue.

In "Personal Finance," Scott Bernard Nelson recommended CD investors not buy long-term CDs. He recommended against building a CD ladder if you did not already have one. He is advising people to fall into a common trap, trying to predict the future and manage return. An investor who puts his or her money into six-month CDs and rolls it over every six months will have less money long term than an investor who puts all of his or her money into five-year CDs. The reason is that the short-term investor has to make up for the lower interest rate in future years. However, interest rates rarely rise fast enough for this to happen.

Smart investors manage risk, not return. A CD ladder is created to guard against reinvestment risk. A CD investor should always build a ladder, regardless of the current rate. A CD ladder is set up by investing 20 percent of your money in each of one-, two-, three-, four- and five-year CDs. Then each year, when your CDs come due, you buy five-year CDs. If interest rates fall, only 20 percent of your money is being invested at lower rates. If interest rates rise, you get to take advantage of the higher rates. Laddering is always a smart thing to do.

WILLIAM D. BARRETT

Barrett Web Services

Cocoa Beech, Florida

Scott Bernard Nelson replies: I'd quibble with the statement that "a CD investor should always build a ladder." There simply isn't a "one size fits all" answer to most money management questions--this one included. On the other hand, I agree that laddering is a smart strategy, and that it's all about not trying to divine the direction of interest rates. That's why I suggested that anyone who has a ladder in place should stick with the plan, regardless of the skimpy rollover rates available.

The question is what to do if you don't have a ladder but might consider one in the future. It's a simple observation that now is not the best of times, with low and rising rates. Going long, then, locks in paltry interest for years to come. A legitimate approach would be to stay short for another six to 12 months while deciding on the ladder option, figuring that longer-term rates are likely to improve by then anyway.

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