Stagger Your Savings (and Maximize the Interest) by Building a 'CD Ladder'

A certificate of deposit (CD) ladder is a strategic approach to investing that can help you maximize returns while maintaining flexibility and access to your funds. This method involves spreading your money across multiple CDs with different maturity dates, creating a "ladder" of investments. This financial move requires a bit of work, but it might be the best way to maximize interest on your emergency fund, especially during times of high inflation. Here's what you need to know about CD ladders and how to build one.

What is a CD ladder?

A CD is vehicle different from a traditional savings accounts because they’re time-based. They're usually offered in terms ranging from three months to five years; longer terms come with higher interest rates. Basically, you give a lump sum of money to a bank in exchange for not making a withdrawal for a fixed term.

The advantage to CDs is that they’re considered a safe way to stash your money, and they typically earn more interest than checking, savings, and money market accounts (currently, it’s closer to 5-6% APY, compared to around 4.50% APY). The downside to CDs is that withdrawing the money early incurs fees that will essentially wipe out any interest you’ve accrued.

A CD ladder, then, is an investment strategy where you divide your money into several CDs with staggered maturity dates. Instead of putting all your money into one long-term CD, you spread it across multiple CDs that mature at regular intervals.

How a CD ladder works

When you build a CD ladder, you'll have CDs maturing in rotation, giving you better access to your cash without paying early withdrawal penalties. As each CD matures, you can decide whether to reinvest the money into a new CD or use the cash for other purposes. For example, with $10,000, a CD ladder will look like this:

$2,000 in a one-year CD
$2,000 in a two-year CD
$2,000 in a three-year CD
$2,000 in a four-year CD
$2,000 in a five-year CD

Then, when the CDs mature, you put that money into a five-year CD, as follows:

$2,000 (plus one year of interest) in a five-year CD
$2,000 (plus two years of interest) in a five-year CD
$2,000 (plus three years of interest) in a five-year CD
$2,000 (plus four years of interest) in a five-year CD
$2,000 (plus five years of interest) in a five-year CD

By doing this, you’re maximizing long-term interest rates, while giving yourself some flexibility to use the cash if you need it, as one CD will expire every year. This approach offers several benefits:

1. Higher interest rates: Longer-term CDs typically offer higher interest rates than shorter-term ones.

2. Regular access to funds: As each CD matures, you have the option to withdraw the money or reinvest it.

3. Flexibility: You can adjust your strategy as interest rates change.

4. Reduced risk: By spreading out your investments, you're not locked into one interest rate for all your money.

There is some risk in this, as you won’t have all of your cash available, unless you want to cash out early and lose interest on the principle. For this reason, you'd never put all your savings or even all of your emergency fund in a CD ladder.

Why not just put that money into stocks?

A couple of reasons: risk and liquidity. There’s always a risk you could lose your money by investing in stocks, and it might not always be easy to sell your stocks at a favorable rate when you’re in an emergency. Plus, you always want a bit of cash on hand, aside from your investments.

Tips for building a CD ladder

1. Start with a plan: Determine how much money you want to invest and over what time frame.

2. Choose your intervals: Decide how often you want CDs to mature. Common intervals are every 3, 6, or 12 months.

3. Begin with shorter terms: If you're new to CD ladders, start with shorter-term CDs to maintain flexibility as you learn.

4. Diversify across banks: Consider opening CDs at different banks to take advantage of the best rates and stay within FDIC insurance limits.

5. Keep track of maturity dates: Mark your calendar with CD maturation dates to make timely decisions about reinvesting or withdrawing funds.

6. Stay informed about interest rates: Keep an eye on current CD rates to make informed decisions when it's time to reinvest.

7. Be consistent: Regularly reinvest maturing CDs to maintain your ladder structure.

8. Adjust as needed: As your financial situation changes, be prepared to modify your CD ladder strategy.

The bottom line

Building a CD ladder can be an effective way to balance the higher returns of longer-term CDs with the flexibility of shorter-term investments. While a CD is less liquid than a savings account (which allows for penalty-free withdrawals), it will earn more interest. You can play around with this CD ladder calculator to see if it’s worthwhile for you. By carefully planning and managing your CD ladder, you can create a stable, low-risk component of your overall investment portfolio.

Creating a CD ladder can be a helpful strategy to increase your earnings while retaining flexibility with your emergency fund, especially during periods of high inflation. To build a CD ladder, you can divide your funds into several CDs with varying maturity dates, such as having a $2,000 CD maturing every year for five years.

This method allows you to earn higher interest rates compared to savings, checking, or money market accounts, while also providing you with the opportunity to access your cash without incurring early withdrawal fees. By strategically managing your CD ladder, you can enjoy the benefits of long-term interest rates and maintain flexibility to adapt to changing financial circumstances.