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Certificates of deposit (CDs) can offer a safe way to save and grow your money. These time deposit accounts offer a guaranteed rate of return at potentially higher rates than you may find with a savings account or money market account. And laddering CDs can help you maximize savings.
So, what is a CD ladder? It’s a strategy that uses multiple CDs to earn interest across different time periods. Using a CD ladder may work for you if you want to maximize your money’s growth while minimizing the odds of triggering an early withdrawal penalty from a CD account.
If you’re ready to give it a try, here’s how to build a CD ladder effectively.
What Is a CD Ladder?
When you open a CD, you’re committing to saving your money for a set period. Banks and credit unions may offer terms ranging from 28 days to 10 years. Once your CD matures, you can renew the CD, roll the money into a new CD or cash out the CD.
Having a CD ladder means opening multiple CDs with varying maturity dates.
As each CD matures, you decide what to do with the principal and interest earned. Since you know when each will mature, you can plan ahead to decide what to do with the money.
One of the benefits of laddering is that you have flexibility—you can choose which CDs to include. For example, you might choose to have five CDs that mature at six months, 12 months, 18 months, 24 months and 36 months. You can open each CD with the same amount of money or put more money in some CDs and less in others.
There’s also the option to open all the CDs in your ladder at the same bank or mix and match CDs from different banks, depending on who’s offering the best interest rates. As a savings strategy, it’s easy to customize a CD ladder to meet your needs.
How to Build a CD Ladder
Creating a ladder CD strategy isn’t difficult, but it’s good to have a plan and some goals in mind. Building a CD ladder begins with making some decisions:
- The total amount you want to save
- The number of CDs you want to open
- How much you want to keep in each CD
- Which maturity terms to choose
- Where you want to open your CDs
Remember, this should be money you won’t need right away. This means that a CD isn’t a good place to park emergency savings since making an early withdrawal could result in a penalty.
Also, think about how you want your money spread across your CDs and how many you’ll need to open. Here’s a CD ladder example that can help you visualize the process.
Say you have $5,000 to save and you want to open five CDs. You could add $1,000 to each CD so that they all have the same amount, but for different terms and at different rates. Your CD ladder would look like this:
- CD 1: $1,000 at 0.50% for 6 months
- CD 2: $1,000 at 0.90% for 12 months
- CD 3: $1,000 at 1.10% for 15 months
- CD 4: $1,000 at 1.25% for 18 months
- CD 5: $1,000 at 1.35% for 24 months
On the other hand, you could choose to allocate them for different amounts, with the highest balance earning the highest APY. For example, something like this:
- CD 1: $250 at 0.50% for 6 months
- CD 2: $500 at 0.90% for 12months
- CD 3: $750 at 1.10% for 15 months
- CD 4: $1,500 at 1.25% for 18 months
- CD 5: $2,000 at 1.35% for 24 months
This CD ladder example assumes that your CDs are ordered by term and APY from shortest and lowest to longest and highest. But, you could flip it around and put the most money into shorter-term CDs and the least into long-term CDs. How you structure your CD ladder depends on your savings goals. Running different scenarios through a CD ladder calculator can give you an idea of how much your savings could grow based on different maturity lengths and interest rates.
As far as rates go, compare what different banks and credit unions offer on various CD terms. Ideally, you should be looking for the best CD rates. This often means shopping at online banks, which generally offer higher APYs than brick-and-mortar banks, thanks to lower operating costs.
Aside from rates, check the minimum opening deposit a CD requires and any early withdrawal penalties that apply. And, of course, make sure the bank is FDIC (Federal Deposit Insurance Corporation) insured. If you’re banking at a credit union, ensure it’s insured by the NCUA (National Credit Union Administration).
Finally, check to see if there are any maximum limits for opening a CD and whether an add-on CD is an option for inclusion in your ladder. Typically, you’re only allowed to deposit money into a CD at the initial account opening. With an add-on CD, you can make the initial deposit and additional deposits to continue growing your money. Consider different types of CDs when building your CD ladder.
Benefits of CD Ladder
There are several reasons to consider using a CD ladder to save versus parking your money in a savings account or money market account. Here’s what you could gain from implementing a ladder CD strategy.
You Can Take Advantage of Higher Interest Rates
When opening a CD account, getting the best annual percentage yield possible may be one of your top priorities. Every bank and credit union is different when determining which rates to apply to CD terms. But, generally, the longer the CD term, the higher the APY.
Creating a CD ladder allows you to take advantage of higher rates without having to put all of your money into a single CD for a single period of time. You can mix and match accounts at online banks and traditional banks to get the best rates and convenience when building your CD ladder.
You Can Capitalize on Interest Rate Changes
Interest rates aren’t set in stone. When rates rise, it’s an opportunity for savers. By laddering CDs with varying maturity terms, you’re in a position to take advantage of higher rates when they come along.
For example, let’s say you have a CD maturing in the next month and, thanks to an interest rate increase, your bank is now offering 2.00% versus the 1.75% you’re earning on your current CD. You could roll the money into a new CD to lock at the higher rate.
At the same time, a CD ladder can help insulate you against interest rate declines. If rates go down, you’ll still earn higher rates on the longer-term CDs you’ve opened.
You Can Avoid Early Withdrawal Penalties.
CDs are time deposit accounts, meaning you’re committing to saving money in them for the duration of the term. Withdrawing money from a CD before it matures often triggers a penalty, which typically means forfeiting some or all of the interest you’ve earned so far.
Having a ladder of CDs with maturity dates spaced out can help reduce your odds of triggering an early withdrawal penalty when you need access to cash. For example, if you’ve spaced out CDs every six months, you don’t have long to wait until your next CD matures.
You Can Save for Different Financial Goals
A CD ladder can also be helpful when saving for a mix of short- and long-term financial goals.
Say your goals include setting aside money for a vacation and putting money away for a down payment on a home over the next five years. You could use a six-month CD to save for your trip while putting money toward a home into a three- or five-year CD.
The shorter-term CD means you’ll be able to withdraw the money without penalty when it’s vacation time. The longer-term CD could allow you to earn a higher APY on savings and grow your down payment fund faster.
Drawbacks of CD Laddering
Creating a CD ladder could help you get more out of your savings efforts while avoiding early withdrawal penalties. But there are some potential downsides to keep in mind.
You May Lose Out to Inflation
CD rates tend to be on the lower side historically compared to some other investments. This can make it more difficult for the interest you earn to keep pace with inflation during periods of rising prices. While you may be earning a steady rate of return from your CDs, your money has less purchasing power overall.
You May Earn a Better Return Elsewhere
Apart from inflation risk, you may earn a better rate of return by investing the money you have in CDs into the stock market. Depending on the interest rate environment, even bonds may deliver higher yields than CDs. More risk is involved when investing in stocks, bonds, mutual funds or other securities, but you have a greater chance of growing wealth.
You May Get Stuck with Low Rates
If interest rates decline, then you could run the risk of inhibiting your money’s growth. If you roll savings into a new rung on your CD ladder when rates are low, you’ll be stuck with them until the CD matures. Even then, you may still have to wait until rates rise again.
Mini CD Ladders
A mini CD ladder is the same as a regular CD ladder with one difference: It’s built using shorter-term CDs.
Here’s an example of a mini CD ladder using a $5,000 deposit:
- CD 1: $1,000 at 0.40% for three months
- CD 2: $2,000 at 0.75% for six months
- CD 3: $2,000 at 0.85% for 12 months
Choosing a mini CD ladder means you have a shorter time horizon for each CD’s maturity. You may choose this option if you want to earn a competitive interest relatively rate on your money while still keeping it accessible. You could also use a mini ladder CD strategy if you expect rates to rise relatively soon.
CD Ladders vs. Other Saving and Investing Options
Laddering CDs has its advantages, but you may be wondering how this strategy measures up against other ways to save and invest.
A savings account or money market account, for example, could offer more convenient access to your savings.
The trade-off is that you may not earn as high an interest rate on a savings or money market account. Choosing a savings account over a CD ladder could hinge on how much interest you’re hoping to earn and how often you’ll need to tap into your savings.
While CD ladders can generate solid interest earnings, the potential return isn’t the same as investing money in the market. As mentioned, investing in stocks and mutual funds could yield significantly higher returns when the market is doing well, which is beneficial when inflation rises. On the other hand, a CD ladder could offer more security and peace of mind if you’re concerned about the risk since CD accounts are FDIC or NCUA-insured and investment accounts are not.
There are also tax considerations involved when saving and investing money, either inside a CD ladder or elsewhere. Interest earned on CD ladders is considered taxable income by the IRS. But the amount of tax you owe may be negligible compared to what you pay for capital gains tax if you’re selling investments at a profit.
Is CD Laddering a Good Idea?
Creating a CD ladder could be a good idea if you want to keep your money in a secure place while earning interest and avoiding early withdrawal penalties. When deciding how to save, it’s helpful to consider where CD ladders fit in your larger financial picture. Different financial goals may be served better by other financial products.
For instance, both a 401(k) and an individual retirement account can be useful when investing for retirement. Meanwhile, a high-yield savings account could be a good choice for your emergency savings. CD ladders can offer a middle ground when you’re saving for both the short and the long term. The more diversified you are with your saving and investing efforts, the better.
Frequently Asked Questions (FAQs)
How much should I put in a CD?
The amount you should put into a CD depends on the minimum deposit required to open and how comfortable you are leaving the funds alone until the CD matures. It can be a good idea to keep some of your savings separate in a high yield savings account or money market account. In case of emergencies, you can tap into those accounts without having to break into your CD early and potentially pay a penalty.
What is the difference between Jumbo CDs and CD laddering?
A jumbo CD is a CD account that requires a higher minimum deposit, usually of $100,000 or more. CD laddering is a strategy that involves opening multiple CD accounts with different maturity terms. Each CD may also earn a different interest rate and APY.
Can you lose money in a CD account?
CD accounts are some of the safest places to keep your money if you have them at an FDIC-insured bank or NCUA-insured credit union. FDIC coverage protects deposits (including CD balances) up to $250,000 per depositor, per account type, per financial institution in the event of a bank failure. The NCUA offers the same protection at credit unions.