What Is a CD Ladder?

Couple using laptop to pay bills
•••

FG Trade / Getty Images

DEFINITION
A certificate of deposit (CD) ladder is a strategy for allocating an amount of savings across multiple CD accounts with different terms.

A certificate of deposit (CD) ladder is a strategy for allocating an amount of savings across multiple CD accounts with different terms. It offers the potential to earn higher interest rates without the risks that come with saving all the money in one account.

Learn what a CD ladder is, how it works, the benefits and risks you should know, and how to tell if this strategy fits your financial goals.

Definition and Examples of a CD Ladder

When you use a CD ladder, you divide your funds between a number of CDs, each with different term lengths. The idea is that each account matures after a different number of months or years.

This strategy lets you take advantage of the better annual percentage yield (APY) you can get with a longer-term CD, while still enjoying the convenience of shorter-term CDs. You get the flexibility to reinvest your principal and interest when the term of each CD expires, or just take the cash.

Each CD you open represents a rung on the ladder, and each will have a different term length. For example, a five-rung CD ladder is a popular choice. A five-rung ladder has five CDs with maturities of one, two, three, four, and five years. You can also use four-rung ladders, which have short-term CDs with maturities ranging from three months to a year or more. Often, you’ll put the same amount of money into each of your accounts, but it’s not a requirement.

CD ladders that contain CDs with terms of one year or less are also called mini CD ladders.

Say that you’ve got $5,000 you want to save using a CD ladder. You could opt for four CDs, with each holding $1,250. If you’re looking for a short-term strategy, you might choose a one-year ladder, consisting of three-month, six-month, nine-month, and 12-month CDs. This method gives you access to all funds within a year, but you’ll likely earn a lower interest rate than if you chose longer terms.

On the other hand, you might feel comfortable with a five-year CD ladder, which could have one-year, two-year, three-year, four-year, and five-year maturities. This method will probably yield higher interest rates, but you’ll have less liquidity.

How a CD Ladder Works

CD accounts are appealing to use with a ladder strategy since you can get a more competitive APY than with a regular savings account. CDs can also provide more predictable yields than other accounts. Say you open a CD account, then choose a set term length—one, three, or five years—then make a lump-sum deposit. Often, your financial institution pays a fixed interest rate, so you don’t have to worry about market fluctuations. However, you can opt for CDs with variable rates if you accept the risk your APY could go either up or down.

When planning your CD ladder, you can choose from various types of CDs to fit your needs. For example, you might opt for a fixed-rate traditional or jumbo CD for the most predictability. On the other hand, you might incorporate a CD with a variable rate responding to market changes, or opt for a liquid CD to avoid penalties for early withdrawals. Keep in mind that your interest rate can vary depending on which CDs you use for your ladder along with the terms you select.

Your financial institution might have model CD ladders you can easily sign up for; however, you can also come up with a custom strategy that might be more complex and even involve working with multiple banks to take advantage of attractive interest rates. In any case, you’ll need to complete an application to open up the specific number of CDs you want, and fund each with your savings amount.

Banks often have minimum deposit amounts that can vary by the type of CD and its term, and this can affect your CD ladder strategy. For example, a jumbo CD with an attractive interest rate might require at least $100,000 to open.

You’ll have control over what you do with each CD’s funds during a grace period upon maturity. Your bank will usually have an auto-renew option so that the maturing CD will just automatically renew with the longest term used and with the current interest rate available. So you might roll your maturing one-year CD over to a five-year one. However, you can also withdraw that maturing CD’s funds and use them as you wish. For example, you might find that another bank has better rates and decide to withdraw and invest that money in a CD there upon maturity.

To get a better idea of putting a CD ladder strategy in practice, consider that you have $20,000 and want to build a five-rung CD ladder. You might do the following:

  • You have your financial institution open five $4,000 high-yield CDs with terms of one, two, three, four, and five years. The interest rates are staggered so that you usually earn more the longer the term is. For example, your interest rates for the one- to five-year terms could be 0.55%, 0.60%, 0.65%, 0.75%, and 0.80%, respectively.
  • As your first CD reaches maturity, you roll it over to a five-year CD to continue building your ladder. You benefit from earning a competitive APY on the original deposit plus the interest accrued during the first year. Considering the other CDs continue to earn interest as well, and at higher rates, you’re better off than if you had all the money in the one-year CD earning 0.55%.
  • You continue deciding what to do when each of the other four CDs reaches maturity. If money is tight, you might take the cash when your second CD’s term is up. On the other hand, you might see that another financial institution has a better APY once your third CD matures, so you might take the money from that CD and reinvest it at the new bank.
  • This process can continue indefinitely until you decide on a different investment strategy for these funds.

Pros and Cons of CD Ladders

Pros
  • Variety of account options

  • Higher liquidity

  • Predictable earnings

  • Insured funds

Cons
  • Lower returns than other investments

  • Inflation risk

  • Potential penalties

  • Taxes on earnings

Pros Explained

  • Variety of account options: A CD ladder comes with options to choose CDs of different amounts and terms. You can shop around to get good rates from various financial institutions, choose from several types of CDs, and customize your ladder to fit your needs.
  • Higher liquidity: Compared to stashing away all your savings in one long-term CD, a CD ladder offers more liquidity since you could always take your money out as the shorter-term accounts mature. At the same time, you can opt to withdraw your funds early, but this usually comes at a cost unless you have a liquid CD and meet the requirements.
  • Predictable earnings: Since many CDs will have a locked-in interest rate from the start, you can easily calculate your earnings across your CD ladder. For CDs with changing interest rates, your financial institution should clearly provide the information when you open the account so you know what to expect.
  • Insured funds: Unlike with investments such as stocks, where you can lose even your initial investment, you usually don’t have to worry about that with a CD ladder. You can get $250,000 in coverage total across CDs at a single financial institution through Federal Deposit Insurance Corporation (FDIC) or National Credit Union Administration (NCUA) coverage. You can use multiple banks and credit unions for your CDs if you save more than $250,000.

Cons Explained

  • Lower returns than other investments: The return you get on CDs can beat the average interest rates offered for regular savings, checking, and money market accounts. However, typical CD interest rates tend to fall short of the potential return on stocks, mutual funds, and bonds, especially when the market performs well and you hold such investments for a long time.
  • Inflation risk: Since even long-term CDs tend to earn relatively low interest rates, your CD ladder earnings may not be able to keep up with current inflation rates. Also, your interest rates could get even lower by the time you need to renew one of your accounts.
  • Potential penalties: If you face an emergency where you need money from any of your CDs right away, your credit union or bank usually penalizes you for the early withdrawal unless you have a no-penalty CD.
  • Taxes on earnings: Like with other forms of interest income, you’ll pay your ordinary income tax rate on your CD ladder earnings. Often, you’ll pay taxes for the interest earned throughout the year even if the CD didn’t mature that year or you didn’t withdraw the money. These income taxes can further cut into your return.

Is a CD Ladder Worth It?

If you’d rather not put your money in riskier investments such as stocks, or have it held up in a single long-term CD, a CD ladder might suit your needs. You just need to accept a predictable yet lower return.

“Investing in CDs with staggered maturity dates gives you flexibility and eliminates the impossible task of trying to predict interest rate shifts,” said Lindsey Bell, chief markets and money strategist at Ally, in an email to The Balance. “Think of it as a disciplined way of managing your CD investments that frees you from trying to speculate on what the market is going to do.”

However, you’ll also want to consider where CDs fit into your overall savings strategy so you can diversify your investments and maximize your returns. Bell recommended a CD ladder as a “good choice for that fixed-income portion” of your investment portfolio. For other funds, you might keep some in a regular savings account for immediate access and invest others in stocks and bonds you can hold for a long time and get a higher return on.

If you decide a CD ladder does fit your needs, customize your strategy based on the current market conditions and your liquidity needs. When discussing using CD ladders in a high-inflation and low-interest-rate environment, Bell said, “It may be less beneficial to invest in a ladder that extends too far into the future. As CD rates rise, you can consider extending your ladder over time.”

Also, think ahead about when you may need the funds so you choose CD terms that reduce the risk of needing early withdrawals and losing money to penalties.

Key Takeaways

  • A CD ladder involves spreading your money across multiple CD accounts–often four or five–that have different maturities.
  • Using a CD ladder can help improve your return versus choosing a single CD that has a short term, and it offers better flexibility than putting everything in a long-term CD.
  • As the CDs mature, you can easily roll over the funds to a longer-term CD, or you can withdraw the cash for personal use or reinvestment elsewhere.
  • This investment strategy offers the benefits of safe, predictable, and more liquid funds, but downsides include a lower return than some alternative investments, inflation risk, and potential expenses such as taxes and early withdrawal penalties.
  • You’ll want to consider the market and your liquidity needs to decide whether a CD ladder is right for you and which structure to use.

Article Sources

  1. Capital One. "What Is a CD Ladder? Is It Worth It?" Accessed Feb. 11, 2022.

  2. Federal Deposit Insurance Corporation. "Deposit Insurance at a Glance." Accessed Feb. 11, 2022.

  3. National Credit Union Administration. "Deposits Are Safe in Federally Insured Credit Unions." Accessed Feb. 11, 2022.

  4. NYU Stern School of Business. "Returns on Stocks, Bonds, and Bills: 1928-2021." Accessed Feb. 11, 2022.

  5. Vanguard. "Benchmark Returns." Accessed Feb. 11, 2022.

  6. Federal Deposit Insurance Corporation. "National Rates and Rate Caps." Accessed Feb. 11, 2022.

  7. Fidelity. "Interest Income and Taxes." Accessed Feb. 11, 2022.