Editorial Note: We earn a commission on partner links on Forbes Advisor. Commissions do not affect the opinions or ratings of our editors.
Certificates of deposit can be a safe way to save and grow your money. CDs offer a guaranteed rate of return at potentially higher rates than you might find with a savings or money market account.
A CD ladder is a savings strategy that involves using multiple CDs to earn interest over different periods of time. There are some benefits associated with using a CD ladder to save money.
One of the most common reasons to build a CD ladder is to avoid paying early withdrawal penalties, while still earning higher interest rates. If the idea of locking your money for one to five years in a single CD is daunting, then a CD ladder may be for you.
Surprisingly, 96% of Americans are unaware of this trick to building wealth. If you’re ready to give Ladder CDs a try, here are the most important things to know.
What is a CD ladder?
To understand how a CD ladder works, here is a quick primer on CDs.
When you open a CD, you are agreeing to save your money on that CD for a set period of time. This is called the maturity period and depending on the CD it can last anywhere from 30 days to 10 years. Once your CD expires, that is, reaches the end of its term, you can either cash in the CD with the interest earned or turn it into a new CD.
Having a CD ladder simply means opening multiple CDs with varying due dates.
As each CD expires, you can decide to turn it into a new CD or withdraw your savings. Since you know when each will mature, you can plan ahead to decide what to do with the money.
One of the advantages of staging is that you have the flexibility to choose which CDs to include.
For example, you can choose to have five CDs that mature at six months, 12 months, 18 months, 24 months, and 30 months. You can open each CD with the same amount of money or put more money in some CDs and less in others.
There is also the option of opening all the CDs in your ladder at the same bank or mixing and matching CDs from different banks, depending on who offers the best interest rates. As a savings strategy goes, it’s easy to customize a CD scale to meet your needs.
Advantages of the CD ladder
There are several reasons to consider using a CD ladder to save money, rather than putting your money in a savings or money market account.
Take advantage of higher interest rates
When opening a CD account, getting the best possible annual percentage return can be one of your top priorities. Every bank and credit union is different when it comes to determining what rates to apply to CDs. But, generally, the longer the duration of the CD, the higher the APY.
Creating a CD ladder allows you to enjoy higher rates without having to put all of your money in one CD for a single period of time.
Capitalize on interest rate changes
Interest rates are not set in stone, and when rates rise, it is an opportunity for savers. By staggering CDs with varying maturities, you are able to take advantage of higher rates when they arise.
Say you have a CD maturing next month, and thanks to an interest rate hike, your bank is now offering 1.00% versus the 0.75% you were getting on your current CD. You can roll the money into a new CD to lock in that higher rate.
At the same time, a CD ladder can help protect against interest rate cuts. If rates drop and banks offer savers a lower APY, you still have the benefit of earning higher rates on longer-term CDs you’ve already opened.
Avoid early withdrawal penalties
CDs are term deposits, which means that you agree to save money on them for the duration of the maturity period. Withdrawing money from a CD before it matures often triggers a penalty, which usually means losing some or all of the interest you’ve earned so far.
Having a CD ladder with spaced out due dates can help lower your chances of triggering an early withdrawal penalty when you need access to cash. If you’ve spaceed CDs every six months, for example, you might just wait until the next deadline to make a withdrawal.
Save for different financial goals
A CD ladder can also come in handy when saving for a mix of short and long term financial goals.
Suppose your goals include saving money for a vacation and saving money for a down payment on a house for the next five years. You can use a six month CD to save for your trip, while putting money for a house in a three or five year CD.
The shorter term CD means you will be able to withdraw the money without penalty while on vacation. Longer term CD could allow you to earn higher APY on savings and grow your down payment faster.
How to build a CD ladder
Creating a CD ladder isn’t necessarily difficult, but it is good to have a plan and a few goals in mind. Building a CD ladder starts with deciding:
- How much do you want to save in total
- How much do you want to save in each CD
- The number of CDs you want to open
- Which deadlines to choose
- Where you want to open your CDs
The most important thing to keep in mind when deciding how much to save is that ideally it should be money that you won’t need right away. This means that a CD would not be your first choice for parking your emergency savings, as having to make an early withdrawal could result in a penalty.
Then think about how you want to split that money over your CDs and how many you will open. Suppose, for example, you have $ 5,000 to save and want to open five CDs. You can add $ 1,000 to each CD so that they all have the same amount, but for different terms.
However, you can choose to distribute them for different amounts. For example, something like this:
- CD 1: $ 250
- CD 2: $ 500
- CD 3: $ 750
- CD 4: $ 1,500
- CD 5: $ 2,000
This scenario assumes that your CDs are ordered by term and APY from shortest and lowest to longest and highest. Or, you can flip it over and put the most money in short-term CDs and the least in long-term CDs, depending on your savings goals. Running different scenarios using a CD calculator can give you an idea of how your savings are growing depending on the length of maturities and interest rates.
When it comes to rates, it helps to compare what different banks and credit unions offer for different CD terms. Ideally, you should research the best CD rates for the types of CDs you want to include in your scale. This often means turning to online banks, which can typically offer higher APYs than traditional banks, thanks to their lower operating costs.
Besides the rates, be sure to check the minimum opening deposit required by a CD and any early withdrawal penalties that may apply. Minimum deposits for one-year CDs typically range from $ 500 to $ 2,500, with some online-only banks offering minimums of $ 0. Longer term CDs can have a minimum of $ 10,000 to start saving. And, of course, make sure the bank is FDIC insured.
Also check if there are maximum limits for opening a CD and if a complementary CD is an option to include in your ladder. Typically, you are only allowed to deposit money to a CD when you first open the account. With a complementary CD, you can make the initial deposit and then make additional deposits to keep your money growing.
CD scales versus other savings and investment options
The CD ladder has its advantages, but you might be wondering how it compares to other ways to save and invest.
A savings account or money market account, for example, could provide more convenient access to your savings. Federal law allows you to withdraw money from these accounts up to six times per month without penalty.
The tradeoff, however, is that you can’t earn as high an interest rate on a savings or money market account as you would with a CD. Choosing a savings account over a CD ladder can depend on how much interest you expect to earn and how often you need to dip into your savings.
While CD ladders can generate solid interest income, the potential for returns is not the same as investing money in the market. Investing in stocks and mutual funds, for example, could generate significantly higher returns when the market is doing well. This is beneficial when inflation rises, as interest rates on CDs may not always keep pace.
While this can help speed up your efforts to build long-term wealth, investing can be risky. There is no guarantee that your investments will increase in value and you can lose money if the market becomes volatile. CDs can offer more security and peace of mind.
When deciding how to save, it helps to consider the big picture and the place of CD scales in it. Different financial goals may be best served by different financial products. For example, a 401 (k) retirement account and an individual retirement account can be useful for investing for retirement. A high yield savings account might be a good choice to hold your emergency savings.
CD ladders can offer common ground when saving for the short and long term. The more diversified you are in your savings and investments, the better.