Learn How CD Ladders Work

Prepare for Unexpected Expenses and Better Rates

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A certificate of deposit (CD) can help you boost your earnings at the bank, but you’ll need to lock up your money for several months or years. Fortunately, a CD laddering strategy can help you keep some flexibility and potentially maximize your earnings.

We’ll go through detailed examples below, but the idea behind a CD ladder is that you buy multiple CDs with maturity dates at various times in the future.

Benefits of CD Ladders

CDs come with strings attached: You have to wait until a CD matures before you pull money out. If you withdraw funds early, you’ll pay a penalty — possibly more than you even earned in interest. You can buy “liquid” CDs that allow you to withdraw funds at any time, but those products tend to pay less than traditional CDs.

A CD ladder is a simple strategy for managing the challenges of investing in CDs.

Need for cash: If you need cash from your CDs, you might not have to wait for long if you’re using a ladder. One of your CDs should mature soon — providing liquid cash without penalty — and hopefully, you won’t need all of your money at once.

Changing interest rates: When you invest money in CDs, you’re typically stuck with the interest rate available when you buy the CD. When rates are high, that works in your favor, but it’s unfortunate to see rates go up after you’ve locked in a low rate. With a CD ladder, you’ll continually reinvest over time, so you’ll update your rate periodically.

CD Ladder Example

A CD ladder is a series of CDs set up to mature over time. For example, you might have $10,000 to invest in CDs, but you don’t want to get stuck with today’s rates or tie up all of your money for several years. You could build a ladder using the following approach:

  1. $2,500 goes into a one-year CD.
  2. $2,500 goes into a two-year CD.
  3. $2,500 goes into a three-year CD.
  4. $2,500 goes into a four-year CD.

Each year (starting after the one-year CD matures), you cycle your maturing funds back into the long end of the ladder. Continuing the example above, the original two-year CD only has one year left until maturity, the original three-year CD only has two years left, and so on. To get back to your original ladder design, you just need to replace the four-year CD. Each year, the cycle continues, and you can just repeat the process (adding a new four-year CD at the end of your ladder).

The example above is a relatively simple ladder, but you can get more complicated if you want — adding six month intervals or longer-term CDs. However, maintaining the ladder gets more difficult as you add complexity. You might have the time and desire to build an intricate ladder now, but things may change in the future.

CD Ladder Length

How long should your CD ladder go? It depends on what you’re trying to accomplish. Most people stop at three to five years. CDs with long maturities pay higher rates because you’re taking more interest-rate and liquidity risk, so a longer CD ladder should earn you a little bit more. That said, if you set up a long-term ladder while interest rates are low, you might actually earn less if rates rise quickly enough — it just depends on your timing and how the future unfolds.

To go long term, you have to be comfortable with locking the money up. For long-term goals, it’s wise to speak with a Certified Financial Planner to explore which long-term strategies best fit your goals.

How Far Apart?

You also have to decide how far apart each rung should be. Should you use three-month CDs or two-year CDs? Most people settle on six-month or one-year maturities within a CD ladder. If you go any shorter, the CD ladder becomes a high-maintenance project (and you're less likely to keep it going). However, you can get creative with CD ladders to accomplish any goal you have. For example, you might time the maturities to match predictable expenses like tuition payments.

When CD Ladders Prove Challenging

CD ladders can help you invest in CDs while managing the risks of unexpected expenses or rising interest rates. However, there are several situations when they’re best avoided.

Short-term use: A CD ladder is a long-term program. If you won’t stick with the program, there may be better alternatives. If you think you’ll have to break down the ladder and cash out, any early-withdrawal penalties might more than wipe out the extra interest you earn. A savings account or a money market account will be more liquid and allow for penalty-free withdrawals.

Rates on the move: A CD ladder allows you to avoid making predictions about interest rate movements — wherever rates go, that’s what you’ll start earning. However, if you can predict that rates are about to rise, it might pay to wait on building your ladder or keep maturities on the short end. Likewise, if you know that rates are about to fall, a ladder that skews toward longer maturities might make sense.

The point of using CD ladders is to avoid thinking about these things, but there may come a time when you can reasonably predict what CD interest rates will do.

Alternatives to CD Ladders

If you decide not to use a CD ladder, where else can you put cash?

High-yield accounts: Savings accounts may be a suitable alternative. Online banks may pay as much as some CDs, and money market accounts can be a middle ground between CDs and savings accounts. You might also look into ‘rewards’ or interest checking accounts, which pay high interest on liquid cash. The problem with these alternatives is that you don’t get a guaranteed rate. Interest rates will fluctuate, and if they head down, then you might have been better off in a CD.

Bullet strategy: If you know when you’ll need all of your money from CDs and you don’t want to keep cycling, a bullet investment strategy may work for you. To use this approach, buy all of your CDs so that they mature at the same time. You might buy the CDs over the course of several years, but you’ll choose maturities that happen at roughly the same time. This strategy can be useful for a known expense.

Barbell strategy: With a barbell approach, you’ll buy just two types of CDs — short-term and long-term maturities. Instead of spreading your maturity dates out over time, you’ll stick to the longest and shortest options available (while skipping intermediate term CDs). For example, your holdings might consist entirely of six-month CDs and four-year CDs, with half of your money in each.