certificate of deposit

Money Basics: Build a CD Ladder


5 February,2013

One of the ways that many consumers attempt to earn higher yields on their cash is with the help of certificates of deposit (CDs). Often CDs come with better rates than many savings accounts, and the money, provided you choose an institution that is insured by the FDIC (banks) or the NCUA (credit unions), is safe, up to $250,000.

For those looking to earn boost yields on cash long-term, a CD can be helpful. However, locking up all of your cash assets for a long period of time can mean that you miss out when rates start to rise. In order to avoid this outcome, many consumers like to use a CD ladder.

How a CD Ladder Works

CD laddering is among the most basic of savings strategies. With a CD ladder, you divide your money into equal parts, and then open CDs for different maturities. A popular method is to base it on a five-year ladder. Say you have $15,000 that you want to put into CDs. You divide that amount by five, meaning that you will open five CDs with $3,000 each. You put each $3,000 in a CD with a different maturity, starting at one year, and then opening one for two, three, four, and five years.

Now, you have it set up so that one of your CDs matures each year. When your first CD matures, you can roll it over into a five year CD. That means that it will mature at year six of your ladder. Once you have this process going, you can renew every CD when it matures for five years. And you will have a CD mature each year for as long as you keep it up.

This strategy is desirable for two reasons:

  1. Longer maturity: In general, a five year CD has a higher yield than short-term CDs. So, once the ladder gets going, your renewed CDs are all for five years, taking advantage of a longer term.
  2. Higher yield potential: One of the problems with locking in a rate for five years is that you lose out if yields rise next year. With a CD ladder, each year you get the chance to lock in a higher yield with one CD. And if rates keep rising, you can keep locking in higher rates as time progresses. If rate fall, though, you are somewhat protected by the fact that your previous CDs are still yielding above the current market.

If you want to use a CD ladder for your emergency fund, taking a longer view might not work as well. Instead, you should consider a ladder composed of smaller time frames, perhaps setting up a six-month ladder, so that you have more regular access to your money. In the case of your emergency fund, it’s more about liquidity and access than it is about yield.

Consider your long-term financial goals and money needs. If CDs fit the bill, consider how you can create a ladder that will help you reach your goals — whether they are long-term or short-term.