CD Ladders: How They Work and Why It’s Smart to Build One

Having multiple CDs with varying maturity dates can help you earn more interest while having regular access to your money.
Last updated Oct 8, 2020 | By Robin Kavanagh
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Opening Certificates of Deposit (CDs) can be a smart money move when the market is volatile. Doing so can ensure your money is safe and growing at a stable rate. But keeping your savings or investment dollars shored up in a long-term CD may not be all that appealing.

Building a CD ladder can help with that. When you have multiple CDs that are timed to mature at varying times, you have what’s called a CD ladder. The idea here is to continually generate interest without having to keep all your money in one account for a long period of time.

Here is a closer look at how CD ladders work and whether they’re worth the investment.

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What is a CD account?

What is a CD? A CD is a special kind of interest-bearing savings account offered by banks, credit unions, and other financial institutions. When you open a CD, you commit to keeping money in your account for a set time period. In return for keeping your money in a CD, the bank or credit union you open the account with pays you interest, often at a higher rate than you would find with a traditional or online savings account.

For example, if you open a two-year CD with $5,000, you agree to keep that money in the account for the next 24 months. During that time, the bank will pay interest based on the annual percentage yield agreed to at the time the account is opened. Interest is compounded at regular intervals, such as daily, monthly, quarterly, or annually. The more often interest is compounded, the more you earn.

When the two-year term is over, your CD matures and you can collect the $5,000 you originally deposited, plus any interest that may have been added to the balance. You can then choose to either use the money, put it into a savings account or the stock market, or even open a new CD.

The higher interest rates are what make CDs particularly attractive. Banks often offer the highest rates for CDs with large balances and/or long terms, and lower rates for short-term CDs. You can often choose to either have interest paid directly to you as a form of passive income or have the interest accrue in the account and receive the earnings when the term is up.

Unlike with a savings account, you can’t add or withdraw money from a CD. It’s a one-and-done transaction. If you absolutely need to access your money, you can usually do so, but you'll likely incur an early withdrawal penalty.

CDs are generally considered safe investments, especially if you open an account with a bank or credit union that is FDIC-insured or NCUA-insured. These programs guarantee that your deposits with a member institution are federally insured up to $250,000 should the bank or credit union should go out of business. FDIC insurance or its equivalent is an important thing to look for when considering a CD.

How does CD laddering work?

If you like the idea of earning more interest but are not too jazzed about having to tie up your savings or investment dollars for a long time, a ladder strategy could come in handy.

When you create a CD ladder, you take the amount of money you want to earn interest on and divide it among several CDs with different maturity dates. By doing this, you are always earning interest and can take advantage of higher rates with longer-term CDs. You’ll also have access to your money each time a CD matures, which allows you to do something else with it or open a new CD to take advantage of new rates and continue the ladder.

How to create a CD ladder

Check out this example. You have $20,000 earmarked for a CD ladder. Instead of opening one CD and tying up that whole amount for five years, you decide to open multiple short-term and long-term CDs at $4,000 each.

Your strategy could look something like this:

  1. One-year CD: $4,000 at .50% APY
  2. Two-year CD: $4,000 at .75% APY
  3. Three-year CD: $4,000 at .85% APY
  4. Four-year CD: $4,000 at 1% APY
  5. Five-year CD: $4,000 at 1.1% APY

Every year in this ladder, you have a CD that matures, which gives you the opportunity to access your money and decide to reinvest it or use it elsewhere. This gives you much more flexibility than opening one CD for a longer term and allows you to access higher CD rates for opening longer-term CDs.

Throughout the five years this ladder is built on, you will earn interest on each CD. You can choose to have the interest paid directly to you throughout the length of the term. This gives you a steady, predictable form of income. If you choose this option, you’ll earn interest only on the $4,000 you put into the accounts.

You could also let the interest accrue in the CD account. If you choose this option, the interest is added to your balance each time it is compounded. This increases the balance that will be used the next time interest is compounded. You’re basically earning interest on your interest when you allow it to accrue in the CD. When the account matures, you’ll get all of the money you deposited plus all of the interest you earned.

When the first CD matures, you get access to $4,000 of your savings and the interest earned on that money and you’re one year closer to each of the other CDs maturity dates. Now you have some choices to make. You could take the money and run, or you could open a new CD that would continue your ladder.

If you continue the ladder, your new CD should be for the longest term you had before. In our example, that’s a five-year CD that also comes with a high APY. When you reinvest the $4,000 that had been earning .50% APY for a year, that money will now earn 1.1% APY for the next five years — and you have two CDs earning at this much higher rate for the next several years.

  1. One-year CD: $4,000 at .50% APY – Matured
  2. Two-year CD: $4,000 at .75% APY – One year until maturity
  3. Three-year CD: $4,000 at .85% APY – Two year until maturity
  4. Four-year CD: $4,000 at 1% APY – Three years until maturity
  5. Five-year CD: $4,000 at 1.1% APY – Four years until maturity
  6. Five-year CD: $4,000 at 1.1% APY – New CD with five years until maturity

If you continue this cycle and the bank your CDs are with keeps these rates steady, in three years, all of your CDs will be earning the maximum APY and you will still have access to some of your money every year.

The benefits of building a CD ladder

Here are the biggest benefits of investing your money in a CD ladder:

  • You’ll earn some of the highest interest rates offered for a savings product.
  • You’ll have regular access to your money with varying maturity dates so you can use as needed or take advantage of APYs that may have increased since you opened your first CD.
  • You will gain a predictable source of passive income by collecting interest payments throughout the CD term or at maturity.
  • This strategy offers a safe place to grow your investment money when markets are volatile.

FAQs about CD laddering

Do CD ladders make sense?

Whether a CD ladder makes sense depends on your individual situation. CD ladders work best when interest rates are good and for large amounts of money distributed across all of the CDs. APYs, in general, have been pretty low over the past few years, but they change all the time. At a time where the rates are high, setting up a CD ladder can lock your money into earning on those higher rates even if they dip during your terms.

Is a CD worth the investment?

That depends on what you want to get out of your investment. CDs are generally considered safer investments than investing in the stock market, especially when it’s volatile. You may not get as much of a return on a CD investment as you would with a stock purchase, but you can usually count on not losing any money when you open a CD. CDs work best as part of a longer-term diversified savings strategy.

Can you get rich off CDs?

Though the amount of interest you’ll earn is predictable, you most likely won’t get rich off CDs.

Is it better to have one CD or multiple?

That depends on what you want out of your CD. If you’re looking to earn interest over a long period of time, you have a substantial amount of money to invest, and would like some flexibility to take advantage of better rates, having multiple CDs in a ladder strategy could be a good idea. If you don’t have a large amount to keep in a CD or don’t want to keep your money tied up for more than a year, a single 12-month CD might be a good fit. It’s really up to you.

The bottom line on building a CD ladder

CD ladders are just a series of multiple CDs timed to mature at regular intervals. They are generally a safe way to earn a higher rate of return on your savings and can be a way to earn passive income. CD ladders work best when APYs are high and when you have a large amount of money to spread over multiple accounts.

This strategy is also more of a long-term investment. It won’t make you rich, most likely, but it would deliver predictable earnings that can grow over decades, which can help you achieve your savings goals. As always, research and shop around for the best banks with high rates before making any decisions about creating a CD ladder strategy for yourself.

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