A certificate of deposit (CD) is a great financial tool you can use to safely invest your cash. And the more CDs you have, the more money you can potentially earn.
To make the most of this financial tool, savvy savers use a technique called CD laddering. By implementing a CD laddering strategy, they’re able to earn a higher overall return on their savings. And with these savings, they can achieve their long-term financial goals such as paying for college or buying a car.
CD laddering might sound difficult, but it’s actually pretty easy. Keep reading to find out how you can use CD laddering to increase your savings faster.
CD Laddering Basics
A CD ladder is a simple way for you to effectively invest your money at a higher rate without compromising the safety of your funds. It’s really nothing more than a series of CDs that are each set to mature at different times, giving you frequent access to some of your money while the rest of it earns interest over time.
The most important factors you’ll want to keep in mind when creating a CD ladder are:
- CD maturity dates
- CD rates
- Your initial CD balance
Your CDs’ maturity dates are important because these dates indicate when you’ll have access to your money. Let’s say you choose to put your money in five CDs. The first CD expires in one year, the second in two years, the third in three years, the fourth in four years and the fifth in five years. When the one-year CD matures, you can roll it into the longest-term CD and continue doing so with each account that has reached maturity.
In addition to picking your CD maturity dates, you’ll want to pick CDs with the best interest rates. Your CDs’ rates determine how much your CD balances will grow after they mature. The higher the CD rate, the higher your balance. And you’ll generally find that the longer the CD term, the higher the interest rate. Most banks and credit unions that offer CDs usually have an online CD laddering calculator that can help you predict how much you’ll have in your savings after each CD matures.
And lastly, your initial balance determines how much money you’ll put in each CD in your ladder. So if you have $25,000 to invest in a CD ladder, you can invest $5,000 in five different CDs.
CD Laddering Pros and Cons
According to the experts, there aren’t really any cons to building a CD ladder. “In most instances, it’s usually a good idea [to create a CD ladder] … it avoids reinvestment risk and interest rate risk,” said Patrick White of John White & Company, which is a full-service financial services company. “It would only be a bad thing if you didn’t have enough capital to truly build out a ladder.”
Some of the advantages of creating a CD ladder include:
- CDs have higher rates of return than savings accounts.
- Not all of your money is invested at the same low rate.
- Long-time laddered investments have higher yields than shorter ones.
- You can set up shorter-term CDs to have more frequent access to your money.
- You can earn more with CD laddering than by re-investing a one-year CD continually.
- If you invest during an economic slump, you can get higher interest rates as the economy improves.
The last point is important remember. Although interest rates on deposit accounts — including CDs — are currently low, they might go up soon. If you create a CD ladder, your CDs will mature at different dates. And if one CD matures during a time when your bank is increasing interest rates, you can put your earnings from that CD into a new CD that’s offering a higher interest rate.
CD Laddering Strategy
There aren’t that many strategies when it comes to building the best CD ladder. As long as you pick CDs with the best CD rates and maturity dates that work best for you, you can expect your savings to grow. But, there are some tips experts recommend when building CD ladder.
For example, White said you want to make sure you have enough capital to really benefit from a CD ladder. “If you only had $3,000 [total] to be put in the CDs, you probably couldn’t build out a true ladder,” he said. That’s why he recommends that people have at least $25,000 to put across five CDs with different maturity dates.
Another CD laddering tip has to do with finding the best CD rates. With any type of deposit account — CDs, savings accounts, money market accounts, etc. — you want to make sure you’re getting the highest, most competitive interest rate available. Most likely, you’ll find that credit unions tend to offer higher interest rates on CD accounts — which they tend to call “share certificates” — than banks.
“I’m a big fan of credit unions,” said Rob Drury, the executive director of the non-profit coalition Association of Christian Financial Advisors. “Being not-for-profit, they usually minimize their fees and maximize their yield … It’s just like loan rates; you tend to get better loan rates at credit unions because there’s just not a concern for profit margin there.”
Related: 11 Best Credit Unions for CD Rates
And here’s a last tip: Many CDs have withdrawal penalties, which means you’ll be hit with a fee if you touch your money in a CD before it matures. But, if your bank or credit union offers CDs that don’t have any withdrawal penalties, take advantage of them. That way, if a financial emergency arises, you’ll have even more accessibility to your money.
In general, however, it’s a smarter idea to leave your funds alone until the CDs in your CD ladder mature. That way, you’ll earn as much interest as possible.
How to Build a CD Ladder
Building a CD ladder is simple. After you figure out how much you want to invest, pick your CD maturity dates and find the best CD rates, put some of your money into each CD account. As each CD matures, roll over your savings into a new CD with the longest term.
Check out the infographic below for a detailed look at how CD laddering works.
CD Laddering Example
Whether you want to earn extra money so you can buy a car in five years or a new flat-screen TV in one year, a CD ladder can help you achieve your financial goals. Remember the tips above, and you can start saving money faster.
Keep reading: How to Open a CD Account