If you’re looking for a reliable, low-risk way to earn on your savings, a certificate of deposit (CD) ladder offers both long-term interest rates with steady returns. As the Federal Reserve continues to raise interest rates, cash accounts like these become even more attractive as they see record-high returns. Still, it’s important to keep in mind that a CD ladder is not an alternative to an investing strategy because inflation often outpaces even the highest of yields.
What is a CD ladder?
A CD ladder is a savings strategy in which you open multiple CDs at different intervals. CD ladders have the benefits of higher interest rates that come with long-term CDs while also having access to cash. Each CD, which are the “steps” that are integral to a CD ladder, is a fixed deposit that earns interest over a specific period.
What makes CDs different from high-yield savings accounts is that the deposit can’t be withdrawn or adjusted during the term or you could face fees and loss of interest. While there are some CDs that don’t carry early withdrawal fees, they tend to have much lower interest rates.
Bump-up CDs are a kind of CD that allows you to adjust the CD’s interest rate once during the period the deposit is maturing. “The [way these work] is that you put the money in and it might be paying 3% or 4%, but if the interest rates jumped to 5% or 6% during your term, you can contact the bank and increase your interest rate in the middle of the term,” says Brent Weiss, a certified financial planner and founding member of Facet.
How CD ladders work
CD ladders work by giving investors staggered returns as the CDs expire one by one. This way, investors can get the benefits of CDs while still getting regular cash yields.
What makes CD ladders effective is that savers have the benefit of longer-term interest rates that are locked in for a set period of time, as well as cash returns since the different CDs are expiring in succession. You could build one CD ladder for a set expense you know you’ll have in the future, such as a car payment or tuition bill, and cash out when the big day arrives. Or, you could also reinvest the money when each CD matures into a new certificate at the best CD rates available at the time, creating an ongoing ladder.
It is important to keep in mind that while CD ladders are a great way to take advantage of high-interest rates, they’re not considered a long-term investment strategy. For goals like retirement savings, a Roth IRA or a 401(k) that invests in equities in the stock market are the best choices. “A major point I want to reiterate is that a CD ladder shouldn’t be an alternative to a longer-term investment or wealth-building strategy,” Weiss explains.
How to build a CD ladder to get staggered returns
The key to building a successful CD ladder is staggering your investments in CDs so that they mature in succession, but not at the same time. For example, if you have $2,500 to invest, you could invest in five CDs that range from one-year to five-year CDs. When one CD matures, you can cash it out and reinvest the money in a new CD that matures however many years away you want to continue the ladder.
If you are new to investing in CDs, shopping around different financial institutions for the best interest rates is a great way to make the most of your CD ladder. Weiss explains that he usually advises his clients to have relationships with at least two different banks so that if one bank has issues they still have an institution available to draw cash from.
The takeaway
CD ladders can be a great strategy for those in retirement or anyone looking to see steady returns in a low-risk, safe savings method. “I always tell my clients, don't just chase the rates, follow your plan and define what you're trying to achieve when putting money either in a high-yield savings account or buying CDs,” Weiss explains. “Make sure that your plan fits what you're trying to achieve in your financial situation.”
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A CD ladder consists of opening several CDs with different maturity dates. A CD ladder's benefit is you can earn high rates and also have access to portions of your money at frequent intervals. With a ladder, you can decide how much money to deposit in each CD and whether to reinvest in a new CD when each CD matures.
A CD ladder is a savings strategy to spread a lump sum of cash across multiple certificates of deposit to take advantage of higher rates — usually in long-term CDs — while freeing up portions of that money at short-term intervals. CDs tend to have the highest interest rates among savings accounts.
The bottom line. "Ultimately, the decision between CD laddering and locking in a long-term rate depends on individual financial goals, risk tolerance and market outlook," says Stivers. If you believe interest rates will stay elevated for the near future or need regular income, CD laddering may still make sense.
If you are retired, you could find building a CD ladder beneficial. This safe investment can help you maximize your returns, while reducing the chances your retirement accounts run dry while you're still relying on them.
How much interest would you make on a $5,000 CD? We estimate that a $5,000 CD deposit can make roughly $25 to $275 in interest after one year. In comparison, a $10,000 CD deposit makes around $50 to $550 in interest after a year, depending on the bank.
If you purchase a short-term CD that matures the same year it was purchased and earn $10 or more, you'll have to pay taxes on it for that year. If the term of such a CD spans over two calendar years, you'll pay taxes on the interest you earn on two consecutive tax returns.
For example, you might be able to build a ten year bond ladder with a bond maturing every year. As the bonds at the lower end of the ladder mature, the proceeds can be reinvested at the long end, in new long-term bonds. If interest rates have risen, you'll be able to take advantage of higher yields relatively quickly.
A Certificate of Deposit (CD) could lose money if funds are withdrawn early, incurring penalties that may exceed earned interest. CDs are generally low-risk and guarantee a fixed interest rate for the term. Early withdrawal penalties can sometimes reduce the principal, not just the interest.
Lowers interest-rate risk: A CD ladder provides regular opportunities to reinvest cash as the CDs mature while reducing interest rate risk. After all, if you put all your funds in one 4-year CD, you may miss out on any rise in interest rates.
Having multiple CDs can be a great way to diversify your portfolio without sacrificing as much liquidity. Risk is low, and CDs provide steady returns. Just know that owning too many CDs could cut you off from other high-return investments. Investing is one part of the financial journey.
If you're a long way out from retirement, a CD probably isn't your best savings option. Retirement accounts like 401(k)s and IRAs offer tax advantages and potentially higher returns in the long run.
Ramsey has referred to certificates of deposit as "nothing more than glorified savings accounts with slightly higher interest rates." Ramsey warned that you shouldn't invest in CDs because average rates won't keep pace with inflation and because they aren't a good place to grow your money.
You typically want to aim for five “rungs” of your ladder with CDs having every single term length from one year to five years. With that in mind, if you had $20,000 to initially invest in your CD ladder, you could invest it like this: CD #1 With a 1-Year Term: $4,000. CD #2 With a 2-Year Term: $4,000.
How much interest would you earn? If you put $20,000 into a 5-year CD with an interest rate of 4.60%, you'd end the 5-year CD term with $5,043.12 in interest, for a total balance of $25,043.12.
You can find 6% CD rates at a few financial institutions, but chances are those rates are only available on CDs with maturities of 12 months or less. Financial institutions offer high rates to compete for business, but they don't want to pay customers ultra-high rates over many years.
That understood, here's what the account will earn based off of some common 6-month CDs rates available online now: 5.35%: $264.01 in interest for a total amount of $10,264.01 after six months. 5.30%: $261.58 in interest for a total amount of $10,261.58 after six months.
Multiple CDs can help you capitalize on interest rate changes if you believe CD rates will change over time. You might put some cash into a higher-rate 6-month CD and the remainder into a 24-month bump-up CD that allows you to take advantage of CD rate increases over time.
"CD rates will most likely drop and drop substantially in 2024," says Robert Johnson, professor of finance at Heider College of Business at Creighton University. "The biggest reason is the likelihood of Federal Reserve rate cuts later this year."
FD laddering is a method in which you divide your entire investment amount among various FDs with varying maturities. Instead of putting all your money into one FD, you can build a ladder of FDs with varied maturity periods.
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