Use a CD Ladder Strategy to Upgrade Business Cash Management

Certificates of Deposit [CDs] provide some of the highest FDIC protected yields for cash investments. CDs with longer time horizons offer even greater rates of return under a normal yield curve, but they require businesses to sacrifice liquidity. Fortunately, a solution exists that allows cash managers to reap the benefits of long-term CDs while maintaining necessary liquidity – a CD ladder strategy.

CD ladders provide many benefits for cash managers, not all related to liquidity. Before discussing these benefits, it makes sense to step back and define the purpose of CD ladders and how to build one.

What Is A CD Ladder and How Do Cash Managers Build One?

A CD ladder is an investment strategy that allows cash managers to capture higher rates of return on long-term CDs while maintaining some shorter-term liquidity. This type of investing strategy is ideal for companies that require cash on a set schedule as well as those that need to minimize the volatility of their investment returns.

To create a CD ladder, cash managers should first determine how much cash should be made available and on what schedule. Once they have determined the ideal timeline for cash availability, they should split their cash among multiple CDs according to that schedule. This should result in a portfolio containing some short-term CDs and some long-term CDs.

Upon maturity of the short-term CDs, cash managers have the option to spend the proceeds of the investment including principal and accrued interest. They also have the option to reinvest the proceeds in a new, long-term CD to preserve the structure of the CD ladder.

When cash managers reinvest CD proceeds, the result should be a series of long-term CDs with staggered maturities. This causes some cash to become available relatively frequently while allowing cash managers to capture long-term rates of return for all the cash they invest in the CD ladder.

CD ladders can increase return over the long run.

When the yield curve is normal, CD ladders will provide an increased return when compared to the rolling-over of short-term CDs during the same period – all other factors remaining consistent. This can be illustrated in a very simple 2-year example:

Scenario 1: Short-Term Rollover

A company invests $1M in a one-year CD with a yield of 1%. At the end of year one, they receive their initial $1M investment back plus $10,000 in interest. They reinvest in another one-year CD with the same interest rate and achieve the same result. Over the two-year timeframe, the total interest earned is $20,100, representing a total return of 2.01%.

Scenario 2: CD Ladder

The company splits their $1M investment equally between two CDs. The first is a one-year CD with a yield of 1% and the second is a two-year CD with a yield of 1.2%. At the end of the first year, their two-year CD is valued at $506,000. They also receive their initial $500,000 investment back from the one-year CD plus $5,000 in interest.

At this point, the company has two options. They could spend the $505,000 from the matured CD if they had a project to fund. Alternatively, they could reinvest it in a new two-year CD at the same 1.2% interest rate.

The initial two-year CD matures at the end of year two, and the company receives their $500,000 investment back plus $12,072 in interest. If they chose to reinvest at the end of year one, the second two-year CD is now valued at $511,060. The total return over two years is $23,132 or 2.31% – a 0.30 percentage point increase over the first scenario.

Continued reinvestment into long-term CDs will result in a portfolio consisting of all long-term investments with staggered maturities. This allows companies to capture higher rates of return than rolling over short-term CDs while ensuring that some cash is available on a regular schedule.

CD Ladders Can Be Crafted To Match Spending Schedules

Those businesses with short or medium-term savings targets are in the best position to take advantage of the superior rates offered by CDs. However, liquid funds are often needed to meet expenses in the short term. In this case, a CD ladder can be a particularly effective strategy.

To illustrate, consider another simple case. A school district has issued bonds for a construction project and will receive a large sum of money up-front. The project’s contractors require payment on two occasions – six months into the project and at completion, which will be a year or more. Instead of allowing the cash to languish in a low-interest savings account, the district could purchase timed certificates of deposit that will expire just before the projected payments are due.

CD Ladders Provide Predictable Returns and Safety

CD ladders can help companies achieve predictable interest income, even when interest rates are volatile. A well-designed CD ladder will have some funds maturing in the near term that can be used to take advantage of rising interest rates. It will also have long-term CDs that are insulated from sudden rate cuts.

The long-term CDs in a CD ladder allow companies to “lock in” current interest rates for the term of the investment. This is particularly beneficial when interest rates are at a peak and expected to decline in the future because companies can achieve high rates of return over a long period of time without sacrificing all their short-term liquidity.

In addition to predictable returns, CDs are an excellent choice for businesses seeking safety since they are insured by the FDIC. This government insurance provides the most robust protection available for business cash. However, coverage is limited to $250,000 per ownership category at each insured bank. Fortunately, modern cash solutions allow businesses to access extended protection.

Should your business invest in a CD ladder?

CD ladders can be a good option for those organizations who want to protect cash reserves, have predictable cash flows, and achieve better returns. A carefully crafted CD ladder, in conjunction with the right cash management partner, can make sure your organization is getting full government protection plus nationally competitive returns.

Access To Extended Protection and Competitive Returns for Your CD Ladder

If you’re looking for the safety and predictability of a CD ladder strategy, contact a member of the ADM team. Our cash management specialists will help you every step of the way – from locating CDs with competitive interest rates to structuring a CD ladder to match your needs.

It is simple to get started with our modern cash solutions. All you need to do is submit an application and make a single deposit. Then, we handle the investments on your behalf and provide a consolidated monthly statement.

To learn more about our CD ladder solutions and get started today, contact us.

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