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Certificates of deposit (CDs) are savings vehicles that offer a higher fixed annual percentage yield (APY) than many traditional savings accounts. The trade-off is that your money is locked away for a set time frame, which can be less than ideal if you need cash or you find a better rate elsewhere.
Using a CD laddering approach can make investing in CDs more flexible. A CD ladder is a savings strategy where you put money in multiple CDs with different maturity dates and interest rates to maximize returns and have the ability to access money at regular intervals.
What Is a CD Laddering Strategy?
A CD ladder provides an alternative to putting a lump sum of money into only one CD. For example, you could build a ladder of CDs with maturity dates of one, two, three, four and five years. In this scenario, a CD would mature each year, and you could use that cash to pay a bill, make a purchase or roll the money into another CD to continue the cycle.
CD laddering is appealing because you're not stuck in just one term, which can be a major benefit if you end up needing cash. Banks typically charge a fee or an interest penalty if you withdraw cash before a CD matures. If you have CDs maturing at different times rather than all at once, there may be less of a risk that you'll need to dip into the cash early.
CD laddering also allows you to lock in rates at different times as market rates fluctuate. Generally, the longest-term CDs offer the highest APY. With a laddering strategy, you can have some money earning a high rate in long-term CDs while also keeping short-term CDs around in case you need cash before the others mature.
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Pros and Cons of CD Laddering
Before setting up a CD ladder, consider some of the pros and cons below.
Pros:
- CD laddering gives you access to your money more often. Using a CD ladder strategy removes the inconvenience of having all of your money tied up for a set period of time.
- CDs offer fixed interest rates. Since rates on CDs are typically fixed, it's a low-risk way to save.
- CD laddering allows for flexibility. If interest rates go up, you can cash out your short-term CDs to invest in new CDs. If rates go down, your long-term CDs will pay out at the higher rate.
- Bank CDs are insured by the Federal Deposit Insurance Corporation (FDIC). CDs at FDIC-insured financial institutions are covered by the FDIC up to $250,000.
Cons:
- CDs offer modest returns. While CDs can offer a higher APY than a regular savings account, you won't get rich from the interest. You're also locked into your rate even if interest rates rise during the term. When you're saving for long-term goals like retirement or building wealth, other investments will likely offer a greater return over time (despite added risk). For short-term earnings, you might want to also consider a high-yield savings account.
- CD laddering can get complicated. CDs have varying deposit minimums, APYs and term lengths. Some CDs require a minimum deposit of $500 or more. You may also find that your bank doesn't offer the best rates for each term you want to add to your ladder. The laddering process can get complicated if you end up managing multiple CDs with different banks or credit unions.
- Some CDs automatically renew. Your institution may give you a specific window in which to withdraw funds after a CD matures. If you don't withdraw during that time, your CD could automatically renew. Be sure to mark each CD's maturity date on your calendar so you can make decisions about what to do with the cash each time a term ends.
How to Build a CD Ladder
The first step to building a CD ladder is shopping around to compare CD rates and terms with different financial institutions. Credit unions and online banks may offer higher APYs than traditional banks, so consider all your options.
The next step is figuring out the maturity intervals you want for your ladder. CD terms of a few months to five years are common, but some banks may offer up to 10-year terms.
Having a ladder with CDs that expire once a year is an easy way to get started, but you could also set up a ladder with CDs that mature every few months. Let's say you have $20,000 to put into a CD ladder, and you choose to break that down into $5,000 deposits.
Here's an example of how that might work for a two-year and four-year CD ladder.
| Two-Year CD Ladder | |||
|---|---|---|---|
| Term | Amount | APY | Interest Earned |
| 6 months | $5,000 | 0.5% | $12.48 |
| 12 months | $5,000 | 0.75% | $37.50 |
| 18 months | $5,000 | 1% | $75.19 |
| 24 months | $5,000 | 1.25% | $125.78 |
| Total Interest Earned | $250.95 | ||
| Four-Year CD Ladder | |||
|---|---|---|---|
| Term | Amount | APY | Interest Earned |
| 12 months | $5,000 | 0.75% | $37.50 |
| 24 months | $5,000 | 1.25% | $125.78 |
| 36 months | $5,000 | 1.4% | $212.95 |
| 48 months | $5,000 | 1.45% | $296.37 |
| Total Interest Earned | $672.60 | ||
Is CD Laddering Right for You?
Before adding savings to a CD ladder, consider your goals and how much you have socked away. Leaving several months of savings in a high-yield savings or money market account could also help ensure there's cash at your fingertips in an emergency.
But if you have a cash surplus that you want to earn a higher interest rate on than what your traditional savings account offers, CD laddering can be a good strategy. With so many CD term length options out there, you can fashion a CD ladder that makes the most sense for you—whether that means laddering for several years or using it as more of a short-term place to park excess funds.