In order to get the best performance from your CD portfolio there are two important considerations. When will you need the funds (cyclical or seasonal obligations) and what are the market rates at the time of investment? If an investor places the funds at a specific maturity (e.g. one year) and continues to roll over the CDs at this term, then at the end of the year, the investor will have a one year average rate, with constant access to the money.
Since rates are much higher on longer terms, the investor would have a much higher average yield on a 3 to 5 year portfolio, but has locked up the money for a longer term. Since the market continually fluctuates throughout the year, the key is to protect yourself against the wide swings in interest rates and still have access to your money.
This is done by staggering your maturities across the yield curve to include short and long-term maturities. This will end up giving you an excellent average yield on your portfolio, and funds will continue to mature for the times you need the money the most.
Let’s take some examples:
Placing $5 million with 90-day maturities
If the interest rate rise, you can continue to re-invest the money as it maturities every 90 days and you continue to place your money at higher and higher rates. This may look great, but if rates fall, you will be getting lower and lower rates each 90 days, and this strategy fails miserably.
Placing $5 million with 5-year maturities
The opposite holds true for long-term placements. If you were to place all your funds at 5-year maturities and rates move down, you look like a hero. But if rates move higher (and they will have 5 years to do so), you get locked into lower rates and this strategy falls apart too.
By staggering your maturities across the yield curve (some long, some short), you protect yourself against all interest rate swings. If interest rates rise, you continually have short-term funds coming due to reinvest at the higher rates. If rates move down, you have locked in the higher yields from your long term investments. This will give you an excellent average on your portfolio and give you access to your money throughout the year.
