How to Create a CD Ladder

Creating a CD Ladder Can Maximize Earings While Adding Liquidity

Ladder leaning on large piggy bank under construction
••• Creating a CD Ladder Can Maximize Earings While Adding Liquidity. Colin Anderson / Getty Images

Creating a CD ladder can be a creative and simple way to take advantage of a traditionally safe investment product. By laddering your CDs, you can maximize your potential earnings and determine the frequency at which you'd like them available.

How CDs Work

Certificates of Deposit, or CDs (occasionally called Term Shares or Term Certificates), are a kind of deposit account offered at almost every bank or credit union.

You may have found yourself wondering how you can set your money aside to earn a little more in interest than the usual tenth or quarter percent that's being offered in a savings account these days. CDs offer you a variety of rates which are better than your savings account. In return, your money is locked away for a term that you choose until it matures and you can decide what to do with it, renew at the current rate, withdraw, or both. Early withdrawals come with penalties, usually from the earnings, but sometimes also costing you some of your principal investment (although exceptions exist in hardships). The longer the term, typically the better the rate.

Typical lengths offered are 3, 6, or 9 months, all the way up to 60 months (five years). Minimum dollar amounts you can put into a CD are commonly $500, with bonus rates sometimes available for larger balances (such as $10,000 or more) or for more established customers/members.

A typical one-year term CD may be around 1% APY. A five-year term may get you up to and around 3%. These deposits, like your savings and checking, are insured by the FDIC or NCUA so there is no worrying about a downturn in the economy causing losses. The interest earned is also typically compounded, which means it too can begin earning even more interest along the way, especially on longer terms.

Be careful to watch the APY (Annual Percentage Yield) and not the APR (Annual Percentage Rate) as the APY is a more universal measuring stick of what you'll earn. CDs are typically compounded monthly or quarterly. The frequency at which a CD compounds can make one bank's 2% give you more profit than another bank's 2%. To differentiate, federal law requires all financial institutions use the Annual Percentage Yield (APY) in addition to the rate (APR). This allows you to compare apples to apples when shopping for rates.

Laddering CDs

A CD's higher rates make it more lucrative than a Money Market account, and its insured nature makes it safer than the stock market. But the money is not available or liquid (without penalty) until it matures at the end of its term. This is where a CD ladder becomes useful. It's not illegal or unethical; a CD ladder is simply an investment strategy.

Say you like a particular rate: 3.2% on a 60-month term CD, but you prefer to have at least some of the funds available annually. The 12-month term only earns .9%. You have plenty of money to invest and you feel you should be getting better than .9%, you just don't want to give it up for so long to do it. A CD ladder could be just the trick.

You open a CD for 60 months with some of your funds, maybe only the minimum required, and you lock in that good rate of 3.2%. But you take your other funds and also open several other CDs, one for 12, 24, 36 and 48 months. These are less than 3.2%, but just wait. The first one for 12 months comes due next year, when you wanted it available. You take what you need, if anything, and leave at least the minimum required and renew it for 60 months, which is now 3.1%. It's changed, but it's still the best rate. The second year rolls around, and your second CD matures.

You then take what you need and renew it for 60 months as well, instead of its original 24. By this time, the current 60-month is offering 3.3%, an improvement. You do this every year, renewing the 36 and 48 month CDs to 60 months at whatever the current rate is knowing it's always higher than any shorter term.

By the fifth year, you are renewing the fifth CD which was already 60 months to another 60. Who knows what the rates will be in five years, but you always know it's better than a 12-month term. Now all your CDs are locked in for a full five years, but a different one comes due every year making that money available penalty free so you can continue with your ladder or use the funds for something else.

You get the rates of a long-term CD with the availability of a shorter term. This simple magic is called a CD ladder. You can make your CD ladder broad like this one, or maybe you want a CD to mature every month, so you create twelve CDs at 12 months, one every month. There is no limit to the quantity or the frequency in your CD ladder, as long as you meet the minimum deposit requirements of your institution. Each is still insured (up to $250,000 total per depositor) and each is locked away earning you the best rate.