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I'd like to challenge the conventional wisdom on creating a "CD ladder".

Looking a certain well-known four-letter-name online bank, I can get:
- a 5-year CD at 2.90%
- a 12-month CD at 1.45%
- Various interim rates for interim terms.
All compounded daily. This bank charges a penalty of the last 60 days' interest for an early withdrawl on a CD.

Conventional wisdom says, divide your money into 5 and create a "CD Ladder" of 1,2,3,4 and 5 year CDs. Then once a year as the newest CD matures, roll that into a new 5-year CD. Then after 5 years you have all your money in 5-year CDs but you still have a CD maturing every year in case you need some of the money.

I don't think so. Let's look at buying only 5-year maturities instead.

If you invest \$10,000 in the 5-year CD, then after 60 days your CD is worth \$10,046.98 and after 120 days it's worth \$10,094.99

Now let's look at the 1-year CD. After 120 days, it's worth \$10,047.38.

So the 5-year CD at 60 days is within a dollar of the 1-year CD at 120 days.

The breakpoint is at 122 days: at 122 days, the 5-year CD - LESS 60 days interest - is worth more than the 1-year CD. There is no mathematical reason to hold a 1-year CD at this bank.

Take this out to the full year, and 365 days after the initial deposit we have:
- The 5-year CD is worth \$10293.41
- The 5-year CD minus a 60-day interest penalty is worth \$10244.46
- The 1-year CD is worth \$10145.65

Even better, at the end of each year, you get to make a new prediction: you can choose to cash in one of the CDs and start a new 5-year CD if the interest rates are better; if they're worse, you can just hang on and hope to find a better rate after another year or two.

I haven't done the math on the 2, 3 and 4 year maturities, but I would bet it's the same story there.

Finally, when considering a money-market account vs the 5-year CD, this same bank pays 1.29% on their money market account. If your money-market account is your "rainy day" fund, try to predict if your first rainy day will be within the next 110 days. If you hold the 5-year CD for more than 110 days, then it will be worth more than the money-market account even after the 60-day interest penalty on the CD.

I hope I am not missing anything... Other than the 60-day interest penalty, I don't see anything that prevents me from buying a 5-year CD and cashing it out after a year or whenever I want.

Obviously this analysis is based on today's rates at that bank and also today's terms and conditions at that bank - your results could be different on a different day or at a different bank (especially a bank that charges a higher early cash-in fee on their CDs)

I hope this is helpful to someone,

Ilikebeer