The Basics of CD Laddering

Right now, many savers are disappointed with the low savings account yields offered by many banks. Many bear the situation because there isn't a safer option in terms of a place to keep your cash.

In order to boost yields, some savers turn to CDs to help find an edge. The downside to that approach, however, is that you might have to agree to lock your money away for five years if you want the best CD rates. (See also: The 5 Best High-Yield CDs.

One way to take advantage of better rates without locking away all your money is to use a technique known as CD laddering.

How a CD Ladder Works

A CD ladder is designed to give you predictable access to your money (just in case you need it), while allowing you to take some advantage of higher yields.

Putting together a CD ladder is fairly straightforward. You begin by dividing the desired deposit into five smaller deposits. Then, you open five different CDs, each with a different maturity. Once one matures, you can then roll it over into a five-year CD (or use the money, if you need it).

Say you have $15,000 in your savings account. Here's how your ladder would work:

  • $3,000 in a one-year CD, 0.90%
  • $3,000 in a two-year CD, 1.20% yield
  • $3,000 in a three-year CD, 1.25% yield
  • $3,000 in a four-year CD, 1.51% yield
  • $3,000 in a five-year CD, 1.62% yield

In one year (year two of your CD ladder), the lowest-yielding CD will mature. Now you have the chance to roll it into a five-year CD. If rates have gone up in the intervening year, you'll be able to take advantage of that with your five-year CD. Even if rates have gone down, a five-year CD is still probably yielding more than what the one-year CD was anyway, so your money is still likely moving into a higher-yielding product.

For year three of your CD ladder, it will be your two-year CD that you roll into another five-year CD. As you can see, setting up your CD ladder in this manner allows you to keep putting money into a longer-term CD that usually has a higher yield.

CD Features to Look For

Choose a CD that compounds interest daily and deposits your earnings automatically into your CD account. That way, your interest earns interest more often, and you can build on the money that you have in your account a little faster.

In our example, the first CD will have a balance of $3,027.12 after one year. After you roll it into a five-year CD with a 1.65% yield at the end of that one year, the next time you access the money it will have grown to $3,286.44. In the meantime, all your other CDs have matured with their interest added to the total, and you are rolling over the principal plus all the accrued interest into new five-year CDs. It's slow going, but anytime you invest in safe, FDIC-protected products, you can't expect to see dramatic returns.

Annual Rollovers Provide Flexibility

Interest rates are expected to rise at some point, and when they do, you'll be in a position to take advantage of the higher rates once a year. In the meantime, you receive some measure of protection from the possibility of falling rates by having your higher yield locked in on your four other CDs. Over time, a CD ladder can provide you with a decent cash cushion, even if it won't provide you with the means to retire (unless you start with jumbo-CD cash).

Does This Work With an Emergency Fund?

A CD ladder can also work as part of an emergency fund. If you want to be able to access your money more regularly, just in case, create a short-term ladder. You can do this by dividing your cash reserve into four sections instead of five:

  • $3,750: three-month CD
  • $3,750: six-month CD
  • $3,750: nine-month CD
  • $3,750: one-year CD

When your three-month CD matures, roll it into a one-year CD, and it will mature at month 15, three months after your original one-year CD expires. Each time a CD expires, renew for a year, and it will mature at the same time annually. If you need the money, you know you'll have it in three months.

The downside to using a CD ladder for an emergency fund is that, as of this writing, a one-year CD is only slightly higher than the rates offered by high-yield savings accounts, and the three-, six-, and nine-month CDs might not have as high rates. This strategy works best if you think that high-yield savings account rates are going to fall, and you want to lock in something right now — just in case.

Using a CD ladder for your emergency fund also presents another conundrum. In the event that you need to access the money before a CD matures you might face early withdrawal penalties. CD laddering can work well as part of a wider emergency fund strategy. Make sure you have more liquid funds in an account that you can access immediately if need be. Those funds should be able to help you stave off financial disaster while you wait for one of your short-term CDs to mature.

Bottom Line

A CD ladder can be a safe way to squeeze a little more yield out of your cash. With rates as low as they are right now, you might not even beat inflation, but your money will be in an account protected by the FDIC in the event of bank failure. You can use your CD ladder to build up a tidy amount of cash over a period of years, or you can use it as part of your emergency fund strategy.

No matter how you use your CD ladder, though, you need to make sure you understand the terms of the CD, including early withdrawal penalties and the rollover policy practiced by the bank.

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Guest's picture

As long as CD yields are below inflation, I wouldn't use any long term CD.

Guest's picture

Very interesting. Never heard of CD Laddering before. This was very informative, thanks.