Certificates of deposit typically have the highest interest rates among government-insured savings products. Although interest rates these days are low compared with historical rates, CDs still make for a safe place to store money with guaranteed returns, as long as you can afford to stow your cash away for a few years.
But the set-it-and-forget-it approach of a typical CD isn’t the only way to use them.
What is a CD ladder?
A CD ladder is a way of setting up multiple CDs so they mature at staggered intervals. As opposed to repeatedly renewing a single CD that holds all your money, a CD ladder will get you higher interest rates without sacrificing accessibility.
The benefits of CD laddering
The price for getting higher interest rates is that you agree to lock in your money for a set time period, sometimes upwards of five years. The longer a CD’s term — and sometimes the larger your deposit — the higher your rates.
You’ll be able to choose longer-term CDs with higher rates and still have certificates maturing on a regular basis.
But while your money is locked away, interest rates could increase, and you wouldn’t be able to take advantage of them. Or an emergency might leave you in desperate need of that cash, in which case you would incur a penalty for withdrawing money before the maturity date. CD laddering provides several benefits:
- Increased accessibility: Your cash will become available to you at frequent intervals.
- Flexibility: You can decide how you want to split up your investments.
- Better interest rates: You’ll be able to choose longer-term CDs with higher rates and still have certificates maturing on a regular basis.
- Peace of mind: If interest rates go up, you’ll have cash to invest in new CDs. If rates fall, you still have money invested in long-term CDs that come with higher rates.
» Want to brush up on CD basics? See our explainer on CDs
How much more will a CD ladder earn me?
The traditional CD ladder model divides your investment evenly over five CDs, with one CD maturing each year. If you had $10,000 to invest, you could spread out your money like this:
- $2,000 in a one-year CD
- $2,000 in a two-year CD
- $2,000 in a three-year CD
- $2,000 in a four-year CD
- $2,000 in a five-year CD
After your one-year CD matures, you can reinvest that money in a new five-year CD. When the second year ends, you can continue this pattern by reinvesting the money from your original two-year CD in another five-year CD. You’ll eventually reach a point where your ladder is made up entirely of long-term CDs, which earn the most interest.
One CD will mature every year, meaning you can either continue investing in five-year certificates or move the proceeds to your checking account.
Let’s assume those CDs compound annually and come with rates that are the same as the national averages for their respective term lengths, as spelled out by the Federal Deposit Insurance Corp.
After laddering your CDs for 10 years, you’d come out earning a total of $832 in interest, bringing your total to $10,832.
Compare that with simply renewing a one-year CD each year for 10 years. Assuming the average annual percentage yield of 0.27% for one-year CDs holds steady, you would earn $273, bringing your total to $10,273.
That’s $559 you would gain by laddering your CDs instead of renewing a short-term CD repeatedly.
Alternative CD ladder structures
Dividing your investment equally among certificates isn’t the only option. Some people like to build their ladders based on economic projections. When the direction of interest rates is fairly clear, you may want to approach your CD ladder a little differently.
When interest rates are rising, consider investing a higher percentage of your money in shorter-term CDs. When rates are going down, aim to lock a higher percentage of your investment in the longest-term CDs you can afford.
When interest rates are rising, consider investing a higher percentage of your money in shorter-term CDs. When rates are going down, aim to lock a higher percentage of your investment in the longest-term CDs you can afford. Keep in mind that a ladder with equally divided investments offers the widest safety net for your portfolio growth.
» Curious about increasing interest rates? Learn what a Fed rate increase means for your CDs
Your perfect ladder
One of the best things about laddering is that you don’t have to follow a single model. You can vary the amount you put in each CD depending on how much you expect to need at future intervals or vary the intervals when your CDs mature. Your perfect CD ladder should suit your investment time frame, need for income and liquidity, and comfort level when investing according to projected economic changes.
Updated Oct. 3, 2017.