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How To Build A CD Ladder
So you’re looking for a strategy that earns more money than a typical savings account or CD?
Whilst this might be the answer for some, these do come with considerably more risk. To avoid the chance of a total loss, you might be better off building a CD ladder.
This advanced saving strategy maximizes your earnings while providing some level of liquidity. It’s a great way to invest a large sum of money without putting it all in one asset, or being at the mercy of the stock market.
What Is A Certificate Of Deposit (CD)?
Before discussing how to build a CD ladder, we need to know what one is!
A CD is a Certificate Of Deposit.
Essentially a CD is like a dressed up savings account. CDs earn higher interest rates than savings accounts, but in exchange, you commit your funds for a fixed period. They provide guaranteed returns as long as you leave the funds in the CD for the entire term.
You’ll find CDs for terms as short as 3 months and as long as 10 years. The longer you can tie your money up, the higher the interest rate it will pay.
What Is A CD Ladder?
CD ladders spread your investment across a series of CDs.
The point is to invest some of your money in longer term CDs to earn the higher interest rates while keeping a portion of it in shorter-term CDs to retain some liquidity.
How Do CD Ladders Work?
A typical CD ladder has 5 ‘rungs’ or maturity dates.
Most people divide their total investment into equal amounts and invest each portion in a CD. This usually starts at one year and increases by one year for each ‘rung.’
When your first CD matures, you’ll reinvest not only the amount you invested but the interest too – straight into a 5-year CD. You’ll do this with the remaining CDs as they mature, which leaves you with five 5-year CDs. One will mature each year, giving you access to your funds and more investment opportunities.
Who Should Build A CD ladder?
You’re probably wondering… who should build a CD ladder? Are they right for you?
Well, anyone can use a CD ladder.
They provide a form of liquidity and a fixed interest rate.
CD Ladders are also great if you’re risk-averse:
- If you simply do not like risk… CD Ladders are much lower risk than assets such as stocks, shares and cryptocurrency.
- Are you nearing a goal? Those nearing a goal often can’t risk losing money in the stock market. You may soon need the cash for a house payment or your upcoming retirement. A CD Ladder may be an intermediary option.
If you open a CD at an FDIC-approved bank, you’ll have the reassurance of the coverage should the bank fail (or be unable to pay out on your CD).
What Are The Benefits Of A CD Ladder?
CD ladders have many benefits including:
- You offset the risk of tying up a large sum of money for too long and not being able to take advantage of rising CD rates. With CDs maturing annually, you can reinvest the funds into a higher rate CD if they become available.
- You choose the CD lengths and amount you’ll invest. Each bank has different account minimum balances and terms, so read the fine print and compare your options. The longer you can tie your money up for, the more interest you’ll earn, but make sure you’re okay with tying your money up for that long.
- You offset the risk of falling rates. With some money invested in long-term CDs, you get the advantage of your higher interest rates for the term of the CD. If rates fall when your shorter-term CDs mature, you can decide how to invest the funds.
What Are The Downsides Of A CD Ladder?
We can’t teach you how to build a CD ladder without explaining the disadvantages.
- CD rates may not keep up with inflation. Keeping your CD ladder within a 5-year maturity usually offsets this risk, but keep it in mind since CD rates are only slightly higher than savings rates.
- There’s an opportunity cost of tying your money up in CDs. You can’t touch the funds until maturity, which is an opportunity cost of not being able to invest in other assets.
- If you withdraw the funds early, you’ll pay a penalty, which is usually a few months’ worth of interest.
How To Create A CD Ladder
To start a CD ladder, you must first decide how much money you’ll invest.
Let’s say you have $15,000 to invest. You’ll divide it among 5 CDs, so $3,000 each.
Each CD is a ‘rung.’
You’ll start with a 1-year CD, investing $3,000 in it. You’ll take the rest of the money, $3,000 at a time, and invest in a 2-year, 3-year, 4-year, and 5-year CD.
At the end of the first year when your first CD matures, you’ll reinvest the $3,000 plus the interest you earned into a 5-year CD, hopefully at a higher rate. Keep doing this for the remainder of the CDs as they mature.
Your CD ladder will now have higher rates and one will mature every year starting with the 1-year CD. If you need the funds and can’t reinvest, you can withdraw the funds from the CD at maturity and receive your earnings.
That’s how to build a CD ladder of your own.
How To Build A CD Ladder - Other Strategies
The strategy above is the typical CD strategy, but it’s not the only one.
Think about how much liquidity you need or how much interest rate risk you want to take. If tying your money up for up to 10 years is too much, consider shorter-term CDs or create a mixture of short-term and long-term CDs.
The key is to have your money spread out across many terms so you aren’t tying all your money up at once. You also have a better chance of earning more interest.
Just be careful that you don’t tie your money up for so long that you end up paying penalties. Most CD’s charge a fine if you need to withdraw the funds early.
A CD Ladder Example
Here is a worked example of how to build a CD ladder.
Open The CDs
You have $15,000 to invest. As discussed, you’ll be starting with 5 “rungs”.
$3,000 into a 1-year CD at 1.90%
$3,000 into a 2-year CD at 2.30%
$3,000 into a 3-year CD at 2.65%
$3,000 into a 4-year CD at 2.95%
$3,000 into a 5-year CD at 3.25%
Reinvest Each CD When It Reaches Maturity
$3,000 plus 1-year of interest: Open a new 5-year CD and deposit these funds.
$3,000 plus 2-years of interest: Open a new 5-year CD and deposit these funds
$3,000 plus 3-years of interest: Open a new 5-year CD and deposit these funds
$3,000 plus 4-years of interest: Open a new 5-year CD and deposit these funds
$3,000 plus 5-years of interest: Open a new 5-year CD and deposit these funds
As per the above CD ladder example, after 5-years you will be left with five 5-year CDs. Due to interest, each of these is worth more than the initial accounts.
For the next 5-years, you will also have a CD ladder mature every year. Again, with further interest.
If you do need some of the money at the time, keep it out as liquid cash. Alternatively, you can continue the CD ladder process in perpetuity.
Remember, if interest rates are rapidly rising, you may want to alter your plan and invest the matured CD fund into a 1-year CD. This allows you to reinvest at a higher rate the following year. If the CD interest rates are high but falling, you’re better off investing for as long as possible.
Hopefully the above example provides a clear illustration of how to build a CD ladder.
What Are The Best CD Ladder Rates?
We’d love to be able to tell you the current best CD ladder rates…
However they will likely have changed between me writing this and you reading it.
What I can tell you is that it’s always worth searching for the current best deals. Don’t just go with your current bank – unless they’re competitive. My current bank offered me just 0.12% on 1-year CD’s. That’s worse than my checking account!
Shop around between reputable online banks – online banks usually offer better rates than traditional banks.
When I learned how to build a CD ladder, I spent an afternoon researching the best rates. It was pretty easy to do with a simple google search. Once invested, I forgot about it for a long time – 12-months to be exact! After the first year, I got in the habit of researching the best rates again around the time my current CD was set to mature. Through my CD ladder I was able to accrue over $5000!
December ’21: Full disclosure, with interest rates presently being so low, I favor index funds over CD’s and no longer renew the next “rung” in the ladder. When interest rates start to rise again, I may reconsider.
Ready To Build Your Own CD Ladder?
Hopefully that explains how to build a CD ladder.
As we’ve discussed, CDs can earn more interest on your deposits than a standard savings account. A CD ladder can offer even more!
When you can stagger your deposits, you’ll tie up your money for varied terms and let your money grow faster. CD ladders are a therefore a great way to achieve a financial goal. You won’t be tempted to withdraw “just a little” for that new iPhone or laptop.
Keep in mind, there’s an opportunity cost. Whilst your money is locked away in a CD ladder, you may stumble across other great investment opportunities. Remember though, having it locked away also prevents you from losing it – should that investment turn out to be not so great.
Figure out the right amount of money to put in CD ladders and consider diversifying your earnings with other investments. A well-diversified portfolio can leave you with the most earnings and help you achieve your financial goals faster.
Now that you know how to build a CD ladder – the choice is yours!
For higher risk but higher return investments, consider: