What Is a CD Ladder?

Photo illustration to accompany article on CD ladders Getty Images
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If you’re looking for a smart way to make CDs part of your savings strategy today, consider building a CD ladder, and maximize interest even as rates remain low.

CDs, or certificates of deposit, aren’t the most lucrative way to grow your money right now, but they can provide a sense of security in uncertain times. While the effects of the current economic recession continue to unfold, storing your savings somewhere safe can bring a valuable sense of peace amid volatility.

And by strategizing with a CD ladder, you’re not only keeping your money safe now, but setting yourself up to maximize interest when rates do start to rise again. 

Typically, opening a CD means agreeing to lock in your cash for the CD’s term, or length, in exchange for a fixed interest rate. If you break that agreement, you’ll generally incur a penalty for early withdrawal. But laddering gives you more flexibility to lock in different rates and stagger your terms. 

How to Build a CD Ladder

To start a CD ladder, you start with an initial sum of cash divided between multiple CDs which mature at different intervals. Depending on your desired timeline, you may choose CDs that mature every six months, every year, or longer. 

Once each of those initial CDs reach maturity, you can choose to liquidate the money if you need it, or continue adding rungs to your ladder by rolling it into a longer-term CD at a higher interest rate. Each time you roll over a CD that’s reached maturity, you’ll build upon your initial ladder but maintain regular maturity intervals.

This strategy gives you more flexibility and liquidity than if you chose a single long-term CD with a higher interest rate upfront. You can still work toward the higher interest that longer-term CDs offer, but retain the option to take your cash out regularly if you need it, as shorter-term CDs mature.

And to really maximize your earnings, shop around and begin building your ladder from different CD types and at different financial institutions that offer terms and rates that work best for you.

Why Build A CD Ladder?

A ladder allows you to sidestep the inflexible nature of CDs. With this strategy, you can form a schedule to increase your liquidity while maximizing longer-term CDs that earn higher interest.

This is a great strategy for money you don’t need immediate access to but would like to save for medium-term goals a few years down the line, like a down payment on a home or new car purchase.

CD ladders are not ideal for savings you need to keep highly liquid, like your emergency fund, which you should keep in a more accessible high-yield savings account. Instead, use a CD ladder for any additional savings you want to earn interest on but don’t want to risk in more volatile investment accounts.

Shorter-term goals

CD ladders are also useful for storing cash you know you’ll need at regular intervals, says Ashley Dixon, CFP, lead planner at virtual financial planning firm Gen Y Planners.

“It never hurts to earn some extra cash on money you already have earmarked for something that’s coming due,” Dixon says.

For example, consider keeping your child’s annual school tuition, a yearly maintenance fee, or regular insurance payment within a CD ladder. Then, set up your intervals so the CDs mature when you need to access that cash. 

CD Laddering In A Low Rate Environment

It’s worth noting a laddering strategy may not deliver the same results now as it might have even a year ago, given today’s historically low interest rate environment. 

Over the past few years, long-term CDs with three- and five-year terms could earn nearly a full percent higher in interest than a short-term CD. The difference today is negligible, if it exists at all.

“In general, this is a great strategy, because longer-term CDs typically pay more than the shorter-term CDs do,” says Robert Farrington, founder of TheCollegeInvestor.com, a blog dedicated to helping millennials pay off student debt and begin earning wealth based in California. “I say typically because we’re in a bit of an atypical time and that’s not the case right now. Right now, you’re seeing a lot of the longer-term CDs at the same rate as a one-year CD.”

Still, even half a percent or less in extra interest will add up over time. That’s why it’s important to shop around for each of the CDs that make up your ladder to ensure they align with your goals.

And though we can’t predict the future, CD ladders offer solid protection from fluctuating interest rates. If rates continue on a downward trend, you’ll be happy you locked in today’s rate for a bit of extra earning potential. But if rates begin moving up quickly, you’ll have the opportunity to cash in on a higher-earning CD without penalty when the shorter-term CD rungs on your ladder mature.

CD Ladder Example

Consider, for example, you have $10,000 saved that you’ll want to access within the next 10 years to go back to school. You don’t want to risk putting it in an investment account, but you’d like to maximize the interest you can earn before you’re ready to enroll.

Using our CD calculator to illustrate an example, if you were to put that $10,000 in a five-year CD earning 1.2% interest today, your total cash at maturity would equal $10,614.

But if you begin building a ladder with CDs at regular intervals, you can potentially lock in higher rates over time and retain partial access to your funds when you need them without penalty.

To begin, you open five CDs which mature at one-year intervals, each containing $2,000. Here’s how each rung of your initial ladder breaks down:

  • $2,000 in a one-year CD earning 0.6% interest
  • $2,000 in a two-year CD earning 0.8% interest
  • $2,000 in a three-year CD earning 0.9% interest
  • $2,000 in a four-year CD earning 1% interest
  • $2,000 in a five-year CD earning 1.2% interest

Note: These interest rates are based on the weekly average national rate from the week of July 1, 2019, according to FDIC data. 

As each CD matures annually, you roll the principal plus interest earned over into a series of five-year CDs. These longer-term CDs will ideally earn higher interest, but still mature in the same one-year intervals, keeping your cash relatively liquid while earning more interest over time. 

If rates were to remain relatively stagnant, here’s how your same ladder might break down after three years of this process:

  • $2,000 in your initial four-year CD earning 1% (one year remaining until maturity)
  • $2,000 in your initial five-year CD earning 1.2% (two years remaining until maturity)
  • $2,012 in a five-year CD earning 1.2% rolled over from initial one-year CD (three years from maturity)
  • $2,032 in a five-year CD earning 1.2% rolled over from initial two-year CD (four years from maturity)
  • $2,054 in a five-year CD earning 1.2% rolled over from initial three-year CD (five years from maturity)

By continually replacing the accounts as they mature, you’re setting yourself up to collect the highest interest available in any given year. Even after three years of laddering in a neutral rate environment, your lowest-earning CD rose from 0.6% to 1%. 

And when rates do begin to rise again, you can ensure all of your money isn’t locked into a single long-term CD at today’s low rates. Instead, you can take advantage as rates grow.

Infographic to illustrate how CD laddering works
Grant Crowder

Bottom Line

A CD ladder is a great way to weather interest rate fluctuations and ensure earnings without giving up liquidity. 

Consider a CD ladder for short- to medium-term goals like a down payment or any standard fees you incur regularly. For more unpredictable emergency savings, a highly accessible high-yield savings account is a better choice, and you’ll earn higher returns for long-terms goals like retirement through more diversified accounts.
When you’re ready to start building the first rung of your CD ladder, compare the best rates available today on NextAdvisor.