A Fixed-Income Redemption Ladder for a Career Break Paycheck
One of the most immediate challenges associated with a career break is that there is no more direct deposit coming into my checking account to pay bills every month. There are a few ways to keep cash flowing. I opted for a redemption ladder with a mix of fixed-income investments. So far, so good. Here’s how mine works.
First, a few definitions. A fixed-income investment is an investment that earns interest at a fixed interest rate, as opposed to a variable rate. It pays interest either in small increments, like once per month or twice per year, or all at once, at the time of redemption. The final day when a fixed-income investment earns interest is also called when it reaches maturity, or final maturity, to be more specific. When a fixed-income investment is redeemed, the principal (the amount paid for the investment) gets returned to the investor, along with any remaining interest to be paid. There are many kinds of fixed-income investments, but I’ve focused on certificates of deposit, or CDs for short, and bonds issued by the U.S. Department of the Treasury.
A redemption ladder with CDs and Treasury bonds is a fairly safe and secure way to lock away funds for access later. Another option is to put my spending money in a high-yield savings account (HYSA) with a bank or credit union. HYSAs have variable interest rates; an introductory “teaser” rate can go down, and many of last year’s teaser rates have already decreased. CDs and HYSAs are backed by deposit insurance, up to $250,000 per depositor, per institution. Treasury bonds are not protected under deposit insurance, although if they’re held in a brokerage account, they might be covered under the brokerage’s insurance for account holders. The U.S. federal government is generally considered to be an extremely reliable creditor; if Uncle Sam stops paying its debts, a lot of people are going to get very upset. This is a possibility in the current political climate, but I’m acting as though it is not going to happen in the next couple of years. Talk to a financial professional if you need to decide what fixed-income investments work best for you. For example, as a Washington resident, I don’t have to pay a state income tax on any interest, but in most states, interest may be taxable income.
As a Fidelity customer, I can purchase CDs and bonds in my brokerage account. (I’m not sponsored by or otherwise financially supported by Fidelity or any other brokerage.) They have a somewhat complicated user interface to search for the best interest rates for particular redemption dates, and they just launched a nice dashboard to show me my upcoming redemptions. Some CDs are callable, which means that they might be redeemed before the date indicated, without paying out the full amount of interest that investors might expect. Callable CDs appear to have higher interest rates, but because, for example, a two-year callable CD might be “called” one year later, a callable CD holder might not get the full two years’ worth of interest. I typically buy call protected CDs, which keep paying out interest until they mature, or until I sell them — more on that later. I can buy “brokered” CDs and Treasury debt on the secondary market, putting together a collection of items that redeem once per month, with interest, throughout the whole year. After my fixed income investments reach their redemption dates, I can automatically transfer the money to a checking or cash management account, so I can pay for my bills and other expenses.
Conventional wisdom holds that a big risk of a fixed-income investment, compared with a HYSA, is that the money is locked up until redemption. This isn’t strictly true with a brokered CD or bond; I could sell the investment to someone else before the redemption date comes around. The interest rate is still fixed, but when people resell fixed income investments, the sale price might be higher or lower than what they initially paid, due to changes in prevailing interest rates.
How much should a person on a career break invest in fixed-income investments? I made my redemption ladder big enough for my expected monthly expenses, plus a little extra. Following the advice in Taking a Career Break for Dummies, I went through my past expenses, made adjustments to accommodate my travel plans and my new, higher, healthcare costs, and produced an annual budget. Expenses vary based on the month, but I avoided having to micromanage by dividing the annual number by 12 and padding it, to handle an outsized expense. Any surplus can be reinvested later.
There are many other, simpler, ways to manage fixed income investments. For example, some bond funds will automatically reinvest funds in particular styles of bonds, for a modest fee, usually well under 1% per year, so investors don’t have to keep re-buying new investments. The highest-paying HYSAs still pay nearly as much as one-year bonds and CDs do, and don’t require much maintenance, although a savings account’s variable interest rate can drop at any time for any reason. Lastly, for career breakers with a higher risk tolerance, it’s still possible to keep money in stocks and other higher-returning investments, as long as they’re willing to risk declines in value and budget enough money to pay for capital gains taxes in the best of cases.
A redemption ladder provides a similar enough experience to a regular directly deposited paycheck, with a little interest as a bonus, so I can keep paying my bills and enjoying my time away from work.