How (and Why) to Create a CD Ladder

Creating a CD ladder is a great way to combine the high interest rates of long-term CDs with the liquidity of short-term CDs. Years ago, laddering certificates of deposit was a lot of work. Not only did you have to go down to your bank to open up multiple CD accounts, but your options were very limited. Today, online saving banks make it easy by offering the best CD rates with terms ranging from 3 months to 10 years, no-penalty CDs, and even rising rate CDs. And you can open a certificate of deposit online in minutes.

So how does a CD ladder work? Put simply, a CD ladder is built by taking a lump sum of cash and investing it in a number of certificates of deposit that have different dates of maturity. By staggering the maturity dates, you are able to take advantage of better interest rates in the future without tying up all your money at one rate for a long period of time. Most people who ladder CDs reinvest the principal when one certificate matures, thus preserving the ladder.

Did you know that not all CDs penalize you for withdrawing your money early?

To get started, you need to answer four questions:

  1. How much money do you want to invest?
  2. How much time do you want to put in between each CD’s maturity date?
  3. How much do you want to invest in each individual CD?
  4. How soon do you want your first CD to mature?

CD Laddering Example

Let’s look at an example. We’ll assume you have $20,000 to invest, you want CDs that mature one year apart, and you want to spread your investment evenly across each CD. So for this example, we’ll divide the investment into $4,000 increments, invested in one, two, three, four and five-year CDs. Based on today’s interest rates, here’s what our initial investment would look like:

AmountCD TermAPY
$4,0001 year1.55%
$4,0002 years2.01%
$4,0003 years2.39%
$4,0004 years2.64%
$4,0005 years3.09%

As the one-year CD matures, it should be rolled into a five-year CD. When the two-year CD matures, you roll it into a 5-year CD, and so on. Every year, you get your initial $4,000 back plus the interest it’s earned. Eventually, you’ll have five 5-year CDs, with one of them maturing each year.

Some certificates of deposit let you benefit from rising interest rates during the term of the CD.

The example we’ve used starts with CDs maturing every year, and builds up to a portfolio of 5-year CDs. There are many other ways CD laddering can work. For example, you could ladder your CDs so that one matures every three, six or nine months. For a six-month ladder, just spread your initial investment across CDs maturing in six months, one year, 18 months, two years, 30 months, and so on up to 5 years. You’ll need to divide your money into more certificates of deposit (10 CDs rather than 5). But the benefit is you’ll have money at your disposal without penalty every 6 months.

One final thought. Several of the best online banks offer what are called no-penalty CDs. As the name suggests, you can withdrawal your money anytime without paying a penalty (actually, you have to wait 7 days from opening the account to take out your money, but there’s no penalty anytime thereafter). I think the best offer available today is from Ally Bank, which offers a 11-month no-penalty CD with a very competitive interest rate.

This option works great in conjunction with a CD ladder. Rather than starting with a 6 or 12-month CD, invest some portion of your savings in the no-penalty CD option. From there, you can begin building longer-term CDs. With the no-penalty CD, you always have access to some portion of your money without penalty.

Topics: Banking

2 Responses to “How (and Why) to Create a CD Ladder”

  1. Suzanne

    This was a great post and very informative, but I do have one comment.

    The interest rates are still deplorable in general. But you might be able to look around and find a general high yield savings account paying above 2.0% I would ladder my cash now in CDs, but I can’t find anything better than what I already have: the AMEX One high yield online savings account that is still paying 2.75% interest. It’s all liquid- I can remove it anytime- and it’s better than most of the 5 year CD rates out there still. My sense is that APY will just grow (slowly), and it might not hit 4.5 or 5% for a few years, at least- but even then, it’s still a better alternative UNLESS we start to see 6% CD rates again (wishful thinking).

    I know that you can’t get an AMEX One card anymore, but AMEX is renewing the ONE card when it expires (mine just got renewed last month for another 4 years). Note that this is NOT the same thing as the regular AMEX savings account that anyone can get online- this only comes with the One card (and the annual fee of $35). But frankly, given that I keep at least 10K in there and always pay my balance in full each month, it takes me 6 weeks to pay the annual fee- and so I get 10.5 months of my savings paying me 2.75%. The math seems clear. 🙂

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