A certificate of deposit (CD) ladder is a savings strategy that lets you lock in guaranteed yields for specific terms while retaining consistent access to at least a portion of your cash. While it can take a little bit of work, it can be a great tool for savings beyond your emergency fund.
What Is a CD Ladder?
Just as a ladder consists of a series of rungs at a fixed distance, a CD ladder is made up of a set of CDs with different terms that mature at regular intervals.
Once the shortest-term CD matures, you open a new CD at the longest term, and the cycle starts again.
For instance, you can create a CD ladder by dividing your cash between a three-month, six-month and nine-month CD. When the three-month CD matures, you open a 9-month CD. And three months later, you’ll buy another one.
This strategy has a few benefits.
By spreading your money across cascading CD terms, you’ll have constant access to at least a portion of your cash. By increasing your liquidity—and knowing when you’ll be able to enjoy that liquidity—you are less likely to end a CD term early and thereby pay an expensive fee.
Moreover, you’re able to take advantage of a changing interest rate environment. You can change or modify your ladder depending on whether rates for a particular CD term rise or fall.
The downside is that you have more of an administrative burden: You’ll need to withdraw your savings once a CD term expires. You’ll have a grace period of roughly 10 days to do so, otherwise, your CD may automatically renew at a lower rate.
Therefore, only go with a CD ladder strategy if you don’t mind consistently opening CDs accounts.
How to Build a CD Ladder
Building a CD ladder is a straightforward process, though there are a few basics to consider.
Start by deciding how much money you wish to dedicate toward your effort. This should be money in addition to an emergency fund, which is preferably held in a high-yield savings account. Once you’ve got that sorted, determine how frequently you want your CDs to mature. This should depend on how long you can leave your cash and the current state of interest rates.
If rates on short-term CD (terms less than two years) are peaking, you might want to concentrate your savings there. But if you suspect long-term rates are likely to fall soon, you might want to add a couple of longer-term CDs to your ladder to lock in the currently higher rates.
Once you’ve determined the amount of money you’d like to spread across your ladder and the frequency you’d like the CDs to mature, the next step is to identify the best CD rates available. (You can usually find the most competitive annual percentage yields (APYs) at online banks or credit unions.)
For instance, you could take $7,500 in savings and put:
- $2,500 in a three-month CD
- $2,500 in a six-month CD
- $2,500 in a nine-month CD
Let’s say the three-month CD yields 4.00% APY. When the term expires, you could pocket the $25 in interest earnings, or simply reinvest the entire amount in a new nine-month CD.
You don’t have to put the same amount into each term. For instance, if you open five CDs ranging from one to five years, and one-year CDs have a higher APY, you might load up more on that term.
Still, it’s generally a good idea to spread your cash evenly across accounts. It’s easier to manage, involves fewer decisions when a CD matures, and you’ll get the benefit of hedging against interest rate risks.
Benefits of CD Laddering
Why go through the trouble of opening several accounts when you can just opt for a savings account? There are benefits to consider.
You Can Take Advantage of Guaranteed Rates
The best CD rates tend to be a tick higher than what you can find from the best savings accounts. But perhaps more importantly, you’re locking in those rates for a set period of time.
Say you open a five-year CD that yields 4.00% APY, and savings rates fall during the course of the term. You’ve locked in at least a portion of your cash for a long period of time, whereas savings accounts are variable and your interest earnings would fall.
Maintain Flexibility
By operating a set of CDs with different terms, you can adapt your strategy as interest rates fluctuate.
For instance, if longer-term rates rise, you can wait until your shortest-term CD matures and then reinvest your principal and interest into a five-year CD, say. When the next CD matures, you can then opt for a three-year CD.
That is, you can slowly shift your CD ladder intervals over time in response to market changes.
If you just had a five-year CD, and shorter-term rates rose, then you wouldn’t be able to take advantage.
You Can Avoid Early Withdrawal Penalties
Unless you have a no-penalty CD, you’ll likely face an early withdrawal penalty should you terminate your CD before the term expires.
This can result in a serious fee. For instance, Ally charges 60 days’ interest on six month CDs. If you haven’t earned enough interest before making an early withdrawal, the bank will likely take the rest of the penalty from your principal. That means you’ll leave with less than what you started with.
CD laddering lessens the need for an early withdrawal. By separating your cash across different terms, you’re guaranteed to receive at least a portion of your cash penalty-free. Moreover, you know when you’ll get the money, allowing you to make do until then.
Drawbacks of CD Laddering
There’s no free lunch, though, and CD laddering comes with trade-offs.
Maintenance Required
In order to execute the strategy effectively, you’ll need to keep track of what CDs you have and when they mature. If you don’t close a CD during the grace period, your bank will usually automatically renew the account. While that’s not the end of the world, it does undermine the purpose of the ladder.
Setting calendar reminders and keeping your account information clearly labeled on a spreadsheet is a simple way to track everything. But if you don’t want to deal with deadlines, a CD ladder isn’t for you.
Not Completely Liquid
While you’ll have regular access to at least some of your cash, you won’t have access to all of it.
Should a crisis arise that overwhelms your emergency fund, you may have to liquidate your CDs early, and thereby face a penalty.
Therefore, only consider this strategy if you think the likelihood of such a situation is low.
Falling interest rates
CD ladders work well as a savings strategy, but it’s possible to endure lower interest rates over time.
Let’s say that you set up a CD ladder with terms of one, two and three years. Initially, the three-year CD yielded 4.00% APY. But (in our example) three-year CD rates fell in the following 12 months to 3.50% APY.
When the one-year CD matures, then, you’ll be reinvesting into a lower yield (3.50% APY). In this scenario, you would have been better off putting all your cash into the three-year CD.
CD Ladder Variations
There are other CD savings techniques that you might consider. For instance, there’s a “mini CD ladder,” which is just a CD ladder concentrated on shorter terms.
Another option is the barbell strategy, where you simply invest in a short-term CD (six months) and a long-term CD (three years). The benefit here is that you’ll have regular access to your cash, while still being able to take advantage of the higher rates you can usually find on longer-term CDs. This strategy has been less useful in recent years as shorter-term CDs yield as much or more than longer-term options.
There’s also something known as a bullet CD ladder. In this strategy, you set up a CD ladder where all the cash matures at the same time. So you open an 18-month CD, and then six months later you open a one-year CD, and then six months later you open a six-month CD.
This can be a good option if you’re wary of putting all of your savings into the CD market, or you’re saving for a specific big purchase that you’ll know you’ll be making at a certain time.
Is CD Laddering a Good Idea?
A CD ladder is a good idea for savings in excess of your emergency fund, since you’re unlikely to tap the savings early.
You’ll be able to hedge against shifting interest rates and maintain a steady flow of at least partial liquidity.
Moreover, it can impose discipline.
If you know that you’ll receive a chunk of cash in three-months, you may be likely to hunker down and stick to a budget during that time period.
However, avoid this strategy if you don’t have at least two months’ income in a high-yield savings, or if you don’t want the headache of operating multiple CDs over the course of months and years.
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Frequently Asked Questions (FAQs)
How much should I put in a CD?
You should only use savings that are in excess of your emergency fund. For instance, let’s say you need to maintain $20,000 in a savings account to meet your emergency fund needs. You could save anything more than that into a CD ladder as a way to earn extra interest and guaranteed rates for as long as the term lasts.
What is the difference between jumbo CDs and CD laddering?
Jumbo CDs refer to the minimum deposit you’ll need to open a CD (perhaps $50,000), whereas CD laddering is where you split your savings across a series of CDs that expire at set intervals.
Can you lose money in a CD account?
You can lose money if you withdraw your cash before your term expires. In this instance, you’ll owe an early withdrawal fee. That’s why it’s important to only save money that you don’t think you’ll need in a pinch.
