Savings account investment strategy: what are laddered term deposits / GICs?

I’ve seen the term “laddering” a lot on highinterestsavings.ca but many people don’t understand what it means. Many people, if asked whether they ladder their investments, will respond with “What is laddering?”. Here’s a short explanation of laddering in the context of term deposits aka GICs.

Laddering not a special type of account, nor something that is only available to some people, nor something you have to apply for. Rather, it is a simple strategy for increasing the interest rate earned on your savings using standard GICs.

Whether you are heavily invested in stocks or whether you are ultra-conservative and won’t put your money anywhere other than a savings account at a major bank, you’ve probably put money in a GIC or thought about it. There are a couple of common concerns regarding GICs:

  • What if you don’t want to lose access to your money for an extended period of time?
  • What if interest rates rise in the future and you miss out on a better rate?

Typically, the savings account offers the lowest rate, and the longer the term of the GIC, the higher the rate. If you’re looking at a 1.5% savings account and a 1.5% 1-year GIC, especially if you think interest rates have hit rock bottom, there is probably no point to investing in the GIC. With the 1-year GIC, you would be giving up liquidity (easy access to withdraw cash) for an arguably negligible benefit (being guaranteed 1.5% for a year and being better off were the savings account rate to drop during that time). And you might look at a 5-year GIC at 2.75% and decide that it’s not worth stashing away your money for so long. You struggle to try to “time” the market; in other words, how do you know when is the right moment to put all your money in a long term deposit? So your money ends up sitting in your savings account unto forever.

Laddering attempts to address those concerns and is best illustrated with an example. Suppose you have $5,000 in savings. You can split that into 5 x $1,000, and start by opening 5 separate GICs: a 1-year, a 2-year, a 3-year, a 4-year, and a 5-year. (Another common surprise for some is that every major financial institution offers 1-year, 2-year, 3-year, 4-year, and 5-year GICs, and often shorter and/or longer terms as well.) This means that you can count on some money becoming available again every year. As each term matures, if you don’t need that money, you can invest it in another 5-year term. If you repeat this process (re-investing each $1,000 + interest amount in a new 5-year term when it matures), you will always be invested in the longest term at the highest rate.

In other words, with laddering you split your money into separate investment bundles, all with different terms and maturity dates, so that you can take advantage of higher rates without locking away all of your money. You can vary this approach in a multitude of ways, such as having 3 years as your longest term or making each bundle have unequal amounts. Also, this concept is not limited to GICs; it can be applied to other types of investments as well.

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