What’s a CD ladder? How to build one

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You’ve probably heard of certificates of deposit (CDs) before. These savings accounts serve as a safe way to grow your savings — if you don’t mind stashing funds away for some time.

The term CD ladder may be less familiar. It’s a strategy that offers more flexibility and the potential to earn higher interest with CDs.

When you open a CD, the longer you’re willing to lock up your money, the higher interest rate you’ll typically earn. This can be inconvenient for some, but a CD ladder solves this issue by staggering the maturity dates.

That way, you can access your money at different intervals, unlike a single CD with a long-term commitment. Plus, you’ll earn a greater return on your money than you would with a traditional savings account.

Here’s how CD ladders work — and tips on how to build your own.

How CD ladders work

A CD ladder is a strategy where you invest in a combination of CDs with different terms. By spreading your money across various maturity dates, you can take advantage of higher fixed interest rates without locking up all your money for years.

The primary advantage is that you’ll get a guaranteed rate of return. You can enjoy higher rates in the short term while still having access to your funds. As each CD matures, you can reinvest the funds to access even higher interest rates.

“By spreading your investments across multiple CDs, you ensure that a portion of your savings becomes available at regular intervals. This liquidity provides flexibility in case of emergencies or unexpected expenses,” says Roger Fishel, a financial advisor.

Example of a CD ladder

To illustrate how a CD ladder works, imagine you have $10,000. To create a CD ladder, you divide your $10,000 equally into four CDs with different maturity dates:

• $2,500 in a 1-year CD
• $2,500 in a 2-year CD
• $2,500 in a 3-year CD
• $2,500 in a 4-year CD

After one year, your first CD matures, and you can either withdraw the funds or reinvest them in a new 4-year CD. Let's say you choose to reinvest it for another four years. After two years, your second CD matures, and you repeat the process by either withdrawing the funds or reinvesting them in a new 4-year CD.

This pattern continues until all CDs in your ladder have matured. Each time a CD matures, you can decide what to do with the funds.

Advantages of a CD ladder

Consider these key benefits of trying this savings strategy:

• Diversification: Spreading your money across various CDs with different maturity dates reduces the risk of tying up all your money in a single CD.
• Liquidity: With a CD ladder, you can access a portion of your funds regularly as each CD matures.
• Interest rate optimization: By staggering the maturity dates of your CDs, you can potentially benefit from rising interest rates. As each CD matures, you can reinvest the funds at the prevailing rates, ensuring your money keeps working for you.
• Lower reinvestment risk: A CD ladder enables you to reinvest smaller amounts periodically rather than investing a large sum all at once. This reduces the risk of locking in your funds at a less favorable interest rate in case rates decrease.
• Stability: CDs are generally low-risk investments that offer stability and security for your money. Using a CD ladder helps you to maintain a consistent income flow while preserving your principal amount.

How to build a CD ladder: A step-by-step guide 

It’s relatively simple to build a CD ladder that works for you. Here are six steps to build your own. 

1. Determine how much you want to invest

First, decide how much money you want to invest and for how long. CD ladders work best with a staggered investment timeline.

“Determine your financial goals and time horizon. Based on your needs, decide on the number of CDs in your ladder, considering factors such as liquidity requirements, income needs, and interest rate expectations,” says Fishel.

2. Choose your CD terms 

Select the terms for your CD ladder. A common approach is to choose CDs with terms that are evenly spaced apart, such as 1-year, 2-year, 3-year, 4-year, and 5-year CDs. This allows you to have a CD maturing every year, providing you with regular access to a portion of your funds.

3. Shop for the best CD rates 

Research and compare CD rates from various financial institutions, including online banks and credit unions. Look for competitive interest rates, but be mindful of any minimum deposit requirements. 

4. Open your CDs 

Once you've identified the best CD rates for your selected terms, open your CDs. You'll need to provide your financial information and fund each CD with the amount you want. Be sure to read and understand the terms and conditions of each CD, including any penalties for early withdrawal.

5. Reinvest maturing CD funds 

As each CD in your ladder matures, you'll have the opportunity to access the funds if needed. However, to maintain your ladder, reinvest the principal and earned interest into a new CD with the longest term in your ladder. For example, if you have a 5-year ladder and your 1-year CD matures, reinvest those funds into a new 5-year CD.

6. Review and adjust your ladder

Regularly review your CD ladder to ensure it aligns with your financial goals and market conditions. If interest rates have risen significantly, consider reinvesting maturing CDs into higher-yielding options. On the other hand, if rates have dropped, you may want to modify your ladder by incorporating shorter-term CDs or exploring alternative investment options.

How to manage a CD ladder

Here are some tips for effectively managing your CD ladder:

• Keep track of CD maturity dates and interest rates. This helps spread the risk and allows you to reinvest at potentially higher rates if interest rates decline.
• Create a reinvestment strategy for maturing CDs. When a CD matures, reinvest the funds in a new long-term CD with the best available interest rate. Explore different banks or credit unions for better rates and terms.
• Periodically reassess and adjust your CD ladder. As your ladder grows, review your financial goals and make necessary adjustments to the structure. Add new CDs or extend the ladder's duration to align with your evolving needs.

The bottom line

CD ladders are a secure and worry-free method to increase your savings. They can provide a stable interest rate, allowing you to maximize your earnings if rates rise and you reinvest your savings.

Additionally, you can choose maturity dates that grant access to some funds in the near future. Including CD ladders in your savings plan is a good idea, but evaluate your financial goals before building one.

Editorial disclaimer: Opinions expressed are author's alone, not those of any bank, credit card issuer, or other entity. This content has not been reviewed, approved, or otherwise endorsed by any of the entities included in the post.