A certificate of deposit is a safe investment that can be appealing to those who have a low tolerance for risk. However, the safer the investment is, the lower its return will be.
Enter the CD ladder, a way to make the most of CDs and earn a higher overall return on your savings. CD laddering involves investing in a series of CDs where each one is set to mature at a different time, which gives you periodic access to some of your money while the rest of it keeps earning interest.
Keep reading to discover how to maximize your CD earnings by using the laddering technique.
CD Laddering Basics
Creating a CD ladder is an effective way for you to invest your money at a higher rate without compromising your funds’ safety. When you create a CD ladder, you should take into account the following factors:
- CD maturity dates
- CD interest rates
- The amount you want to invest in your CDs
Your CDs’ maturity dates indicate when you’ll have access to your money. For example, say you put your money in five CDs. The first CD expires in one year, the second in two years and so on. When the one-year CD matures, you can roll it into the longest-term CD and continue doing that with each account that has reached its maturity.
In addition to picking your CD maturity dates, you’ll obviously want to choose CDs with the best interest rates. You’ll generally find that long-term CDs offer a higher interest rate than short-term CDs.
The amount you want to invest 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
There aren’t really any cons to building a CD ladder. By using this laddering technique, you are avoiding the two downsides usually associated with CDs: the interest rate risk and their low liquidity.
“The trick to [creating a CD ladder] effectively is to pick the right spacing of the rungs and the right overall length of the ladder for your particular situation, taking into account the interest rate environment at the time you’re building the ladder,” said Scott Halliwell, a USAA Certified Financial Planner. “It’s also important not to extend the ladder too far out so that you miss out too much if interest rates start to increase while the ladder’s in place.”
CD laddering offers several advantages that make the strategy an enticing one for investors:
- 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 some short-term CDs to gain more frequent access to your money.
- If you invest during an economic slump, you can get higher interest rates as the economy improves.
The last point is important: Although interest rates on deposit accounts — including CDs — are currently low, those interest rates might go up soon. 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, higher-rate CD.
Considerations for Your CD Ladder Strategy
When it comes to building a CD ladder, keep it simple. Here are some tips that might help you build yours.
Write down what you want to do with your savings and when you’ll need access to the money; your access needs will determine how many CDs you buy and how long their terms should be. It’s a good idea to invest in your ladder CDs with the same bank, because it will be easier to keep the CDs organized if they’re in one place and tied to one savings account.
If you’re planning on laddering, choose maturities that are one, two or even five years out. Any earlier maturity dates will require you to purchase a new CD every three to six months to keep your ladder in place.
How to Build a CD Ladder
Starting a CD ladder is easy. Follow this CD ladder example that illustrates a $25,000 investment for a five-year ladder.
Open five CDs with $5,000 each, with ascending maturities 12 months apart. This way, you’ll have access to some of your money every 12 months as your CDs come to term as well as the interest-earning power of the longer-term CDs.
When your 12-month month CD matures, you can take your money out or renew the CD to keep your ladder going. Once all the original CDs have been renewed, the ladder works automatically.
CD Laddering Might Be for You
As you now know, CD laddering can help you earn greater returns on your CD investments and access some of your money periodically, which makes this a win-win financial strategy. Taking full advantage of your CD investment options — including laddering strategies — will likely enhance your returns over time, so if you want to make your cash work harder for you, consider adding this technique to your financial playbook.