How to Adjust Your CD Ladder When Rates Change

How a CD Ladder Works

Certificates of deposit are savings accounts that earn interest for a set term, typically from one month to five years. Since withdrawing funds before the CD's term ends typically triggers an early withdrawal penalty, your money isn't easily accessible. CD laddering provides more flexibility.

To ladder CDs, you invest in at least three "rungs" of CDs whose maturity dates are spread over time. As CDs mature, you receive portions of your savings at various intervals without paying a penalty.

You can use CD laddering to save for a future goal, such as buying a home, without locking all of your savings into one CD and maturity date. For example, if you're saving for a down payment on a home in five years and starting with $5,000, you could ladder CDs as follows:

• $1,000 in a one-year CD
• $1,000 in a two-year CD
• $1,000 in a three-year CD
• $1,000 in a four-year CD
• $1,000 in a five-year CD

CD laddering helps insulate your savings from interest rate fluctuations. As each CD matures, you have the option to renew it, use the cash or invest it elsewhere. The laddering strategy also provides more financial flexibility than putting all $5,000 in one five-year CD. If you need the money in the CD for other purposes, you can wait until your 12-month CD matures instead of tapping your five-year CD early and being penalized.

Whether laddered or not, CDs can be appealing if you'd like a low-risk investment with guaranteed returns. CD interest rates are generally higher than savings account annual percentage yields (APYs) and are locked in for the term of the CD, while the APY on a savings account typically changes with the federal funds rate. Many people use CD laddering to create an income stream in retirement or save for a future goal.

Learn more >> How Many CDs Can You Have?

What Fed Rate Cuts Mean for CDs

Banks use the federal funds rate set by the Federal Reserve when determining the APY of CDs and other types of deposit accounts. CD interest rates typically rise and fall in tandem with the federal funds rate. In September 2024, the Federal Reserve lowered the federal funds rate by 0.5%, and more cuts are anticipated by the end of the year.

As of August 2024, some financial institutions offered CDs with APYs as high as 5.65%. However, projected reductions in the federal funds rate mean CD interest rates are likely to decline. Since CDs have guaranteed interest rates, purchasing CDs now could help you lock in high APYs.

Learn more >> What Causes CD Rates to Change?

How to Adjust Your CD Ladder When Rates Go Down

If you've already got a CD ladder in place, here's what to do as interest rates go down.

• Compare available rates. Evaluate your current CDs' APYs against what's offered elsewhere. Online banks and credit unions often offer CDs with higher interest rates than CDs at traditional banks.
• Take advantage of add-on CDs. Unlike traditional CDs, add-on CDs let you make additional deposits during the CD term. If you already have an add-on CD with a high interest rate, consider putting more money into that account before rates drop.
• Explore extending your CD ladder. If your current ladder ends in two or three years, when interest rates are predicted to be lower, purchasing a longer-term CD could assure today's higher interest rates going forward.
• Consider terms as well as interest rates. The CD with the highest APY isn't always the best choice. If you put $2,500 in a one-year CD with a 4.25% APY and interest rates drop in a year, you may struggle to find a new CD with a comparable return. A five-year CD with a slightly lower APY could be a better option.
• Track your maturity dates. Once a CD matures, you typically have about seven to 10 days to decide what to do with your funds. If you do nothing, some CDs automatically renew, which could lock you into a lower rate than you'd like.

How to Adjust Your CD Ladder When Rates Go Up

When interest rates rise, your existing CDs' interest rates become less competitive. Here's how to adjust your strategy.

• Reinvest maturing CDs into higher-earning options. As each rung on your CD ladder matures, you can move the funds into CDs with higher interest rates.
• Assess your CDs' APYs. Depending on how far interest rates have risen, paying an early withdrawal penalty to move your money into a CD with a higher return could be worthwhile.
• Consider investing in short-term CDs. If you think interest rates may increase further, buying three-, six- or 12-month CDs gives you the option to reinvest as rates rise.
• Take advantage of no-penalty CDs or bump-up CDs. No-penalty CDs can be cashed out before maturity with no penalties so you can shift your money to a CD with higher returns. Bump-up CDs let you request a higher APY during the term if interest rates rise.
• Evaluate your financial goals and timeline. Is a CD ladder still the best strategy for you, or would a different approach work better?

Pros and Cons of CD Laddering

Before adding CD laddering to your savings plan, it's important to understand the benefits and drawbacks.

Pros of CD Laddering

• Low risk: CDs are considered a safe investment because they offer a guaranteed rate of return.
• Diversification: A CD ladder can balance out riskier investments such as stocks.
• Usually federally insured: CDs from banks insured by the Federal Deposit Insurance Corp. (FDIC) are guaranteed up to $250,000 per depositor, per insured bank for each account category. Similar protections are available for CDs purchased through insured credit unions.
• More flexibility than a single CD: Although you'll still need to leave your money in the CD until maturity to avoid a penalty, purchasing staggered CDs provides more liquidity than a single, longer-term CD.

Cons of CD Laddering

• Relatively low interest rates: CD earnings may not keep up with inflation. Your money might earn more elsewhere.
• Minimum deposit may be required: You typically have to deposit a minimum amount to open a CD. Getting the highest interest rates may require a large initial deposit.
• Automatic renewal: Some CDs renew automatically if you don't act quickly when the term ends. If you aren't paying attention, your money could get locked into another CD.
• Complexity: CD laddering can be complex to manage, especially if you have CDs at different financial institutions.

Learn more >> Are CDs Worth It?

Alternatives to CD Ladders

If you want to build savings while enjoying liquidity, high-yield savings accounts and money market accounts can be useful alternatives to CD ladders.

High-Yield Savings Accounts

High-yield savings accounts let you access your money whenever you want, while typically earning interest rates similar to those of CDs. Unlike CDs, however, APYs on high-yield savings accounts aren't guaranteed; they may rise or fall based on market factors.

Money Market Accounts

Money market accounts combine elements of checking and savings accounts. They earn higher interest than typical savings accounts and can also be used to write checks or perform debit card transactions. However, the number of transactions you can make per month without a fee is usually limited. You may also have to maintain a high minimum balance to get the highest APY.

Bonds

When you buy a bond, you're lending money—typically to a government entity or corporation—for a period usually ranging from one to 30 years. Bonds generally pay out interest every six months. They may be issued by the federal government (Treasury bonds); by cities, counties and states (municipal bonds); or by corporations. Bonds are considered low-risk investments, but they also have relatively low returns compared with stocks.

Dividend-Paying Stocks

Some stocks pay dividends to stockholders, so you can earn money without having to sell the stock. Dividends are usually paid on a regular schedule and can provide a steady income stream. However, they may be negatively affected by rising interest rates, and returns aren't guaranteed.

Lock In High CD Rates

Whenever interest rates change, it's a good idea to revisit your CD ladder and make any necessary adjustments. Locking in high rates on CDs before yields drop can help you make the most of your savings and reach your financial goals.

Good credit can also help you achieve your financial dreams. As you review your savings strategy, consider signing up for free credit monitoring from Experian. You'll get notified of important changes in your credit report and score so you can easily keep on top of your credit health.