Here’s the no frills answer: A CD ladder is a savings strategy where you spread a lump sum of money across multiple CDs with different maturity dates.
What does that really mean? Well, it’s a more tactical way to boost your savings.
The goal of building a CD ladder is to lock in high APYs (Annual Percentage Yields) across multiple CDs, instead of lumping all of your funds into one CD. Those multiple CDs will mature (in other words, the CD term has ended) at different points in time. As each CD matures, your cash will free up to either use or rollover into new CDs.
If this is feeling a little complicated, don't worry. Read on. Just think of it as learning the rules to a new game. We’ll explain how it works, outline some examples and show you how to build a CD ladder that works for you.
Let's start with a quick refresher. A Certificate of Deposit (CD) is a type of savings product that typically has higher interest rates than a traditional savings account, and a fixed maturity date. Most CDs are FDIC-insured, so you can rest easy knowing your money is protected. The catch is that your funds are locked for a set amount of time, meaning you typically can’t withdraw your balance before the CD matures without paying a penalty.
Side note: No-Penalty CDs typically allow you to withdraw your balance beginning seven days after funding, with no penalty. However, for the purposes of this article, we’ll be looking at traditional CDs, where you’re locked into a rate for a fixed amount of time.
When you put all of your money into a single CD, your money is tied up until your CD matures (unless you’re willing to potentially pay an early withdrawal penalty). We hate to use the cliché of having all of your eggs in one basket, but…that’s really what you’re doing.
That's where a CD ladder can come in handy.
By spreading your pot of money across multiple CDs, a CD ladder offers you flexibility. Part of your money becomes accessible each time one of your CDs mature.
It’s also worth noting that while fixed-rate CDs provided a guaranteed rate of return, CD rates available in the market may fluctuate depending on a number of factors. Since you can’t really predict whether CD rates will go up or down, laddering your CD lets you hedge against the unknown of how rates will shift.
Another perk of CD ladders? You’re able to take advantage of rates on longer-term CDs, which are typically higher, without committing all of your money to that CD.
Before we get into the details of how CD ladders work, let’s start with an example. Say you use $25,000 to build a CD ladder that matures in one-year increments:
When the 12-month CD matures, open a new five-year CD. When the 24-month CD matures, open another five-year CD, and so on. In five-years, you’d have only the higher-yielding, five-year CDs in your ladder – and every year, one of them would mature.
The idea is that the first part of your ladder is built with baby steps (shorter-term CDs) so that you have access to some amount of cash each year. As time passes, your ladder will evolve so that it’s primarily constructed of longer-term CDs (earning you higher APYs), but you still have access to cash each year.
Let’s assume you want to put your money in CDs that earn the highest possible interest rates. Typically, this means selecting CDs with longer terms. You might be uneasy at the thought of locking up all of your cash for an extended period of time. So what do you do?
In this case, you could place smaller amounts of money in short-term, medium-term, and long-term CDs that mature at staggered intervals – like the steps of a ladder. When your short-term CD matures, you can take that money (and the interest you’ve earned on it) and put it in a long-term CD. Alternatively, if you need the cash when the CD matures, you can withdraw the funds.
Eventually your ladder would consist of only long-term, higher-yield CDs. This laddering approach allows you to gradually commit cash to longer-term, typically higher-yield CDs.
There is no “best” strategy – it’s about picking the strategy that’s appropriate for you based on how frequently you’ll want access to the cash. Here are some general tips:
CDs with longer terms may help you earn more over time. One thing to remember about opening CDs that mature in a year or more is that you lock up your money for that period. You could access the funds if you needed to, but in most cases (depending on the terms and conditions applicable to the CD), you may be required to pay an early withdrawal penalty, which would reduce your principal.
If you’d like more frequent access to your money, consider building a ladder with CDs that mature more quickly – for example, you could ladder six-month CDs. A six-month CD ladder can be more time-consuming to manage, but you could also have access to your funds (without an early withdrawal penalty) more frequently.
It’s generally a good idea to have three to six months of living expenses set aside as your emergency fund. You could set up a CD ladder to do this, but again, be aware that access to your money is fairly restricted.
If that makes you uneasy, consider a high-yield savings account or even a No-Penalty CD. You could also set aside some portion of your emergency fund in one of these accounts, and then build a CD ladder with another portion. This way, your money won’t be completely tied up if a leaky roof or car problems require immediate financial attention.
Remember that a CD ladder is a savings strategy, and might not necessarily bring you the same returns as investing. But CDs come with far less risk, and that can give you some peace of mind. Consider taking advantage of that security and the ability to lock in rates, and use CDs as one of several savings tools to help bring balance to your financial life.
*Annual Percentage Yield (APY): stated APYs are for illustrative purposes only and do not necessarily reflect APYs that are currently available.