Person-to-Person Loans, Laddering and Short-Term Savings

Posted by Mike Smith :: November 29, 2007 @ 6:47 am

In my recent post about short-term savings, I talked about creating an emergency fund with three to six months’ worth of savings. A great way to implement that savings plan is to use a laddering technique.

To help explain the laddering technique, let’s look at an example using the most classic implementation: using Certificates of Deposits (CDs). CDs have different terms and different interest rates. If you were to implement a CD ladder, you would invest your money in multiple terms, such as a 3-, 6-, 9-, and 12-month CD. Each time a CD matured, you would reinvest the proceeds in a new 12-month CD. So after 3 months, your 3-month CD would mature and you’d buy a 12-month CD. You would then have 3 months left on your 6-month CD, 6 months left on your 9-month CD, 9 months left on your original CD, and 12 months left on your new 12-month CD. An alternative method using CDs would be to buy 12-month CDs every month for a year.

The traditional thinking behind using CD laddering is that you can get the higher returns that CDs offer over many traditional savings accounts, while still having some access to your money. While your money is tied up as you create the ladder, once it’s established you’ll have at least some of your money coming out on a regular basis.

While using CDs to build your ladder is one method, it certainly isn’t the only one. Laddering also works very well for Lending Club person-to-person loan portfolios. You could create new portfolios at different times to own loans that reach maturity at different times. Even simpler, you can just reinvest the money that you receive from your loans each month to achieve the same goal. Since loans on Lending Club are scheduled to be repaid on a monthly basis for 36 months, you automatically have the characteristic of a ladder in that a portion of your investment is returned to you each month. If an unexpected expense arose, you could stop reinvesting the money for a month or two and instead withdraw it from your account.

When you consider the fact that Lending Club person-to-person loans offer lenders better rates than CDs, while still preserving the laddering feature of returning a portion of your investment to you each month, you may find that a portfolio of loans is a better fit for your financial goals than a laddered CD. Either approach is a viable way to build up your emergency fund and one that you may want to consider.