When you’re researching CD rates, you’ll notice that longer-term CDs have better rates than those with short terms. For example, one bank is currently offering a 2.4% APY on a 5-year CD, but only 1.29% on a 12-month CD and .64% on a 3-month CD. Naturally, you want to take advantage of the highest interest rate.
However, you may not feel comfortable having your money tied up for so long. Creating a CD ladder lets you invest in the higher rate CD, but you only have part of your money invested so you still have some degree of liquidity.
How a CD Ladder Works
You invest in several CDs each with different terms, so the maturity dates are staggered. When the shortest-term CD matures, then you’ll reinvest that money in the longest-term CD as long as you don’t need the money. Then, after another term you’ll have another CD maturing and you’ll repeat.
CD Ladder Examples
Say you have $4,000 to invest and you want to build up to a 12-month CD. You can create a 12-month CD ladder. You would invest $1,000 in a 3-month CD, another $1,000 in a 6-month CD, $1,000 in a 9-month CD, and the final $1,000 in a 12-month CD.
In three months, the first CD will mature. You can keep the money if you need it or you can continue your ladder by reinvesting money in a 12-month CD. In three more months, your 6-month CD will mature. Again, invest that money in a 12-month CD. Every three months, a CD will mature and you’ll reinvest in a 12-month CD. At the end of the year, your money will be invested in 4 12-month CDs that mature every three months.
You can do the same thing with five year CDs, which typically have a higher interest rate. You would invest your money in five CDs – 1-year, 2-year, 3-year, 4-year, and 5 year CDs. Each year a CD will mature and you’ll reinvest the money into a 5-year CD. After the 4th year, all your money will be invested in 5-year CDs at the highest available interest rate.
Benefits of a CD Ladder
A CD ladder makes it easy to invest your money in longer term CDs, without giving up access to your funds all at one time. It also lets you take advantage of CD rate increases. Once you lock-in a CD rate, you can’t invest in a higher rate CD without coming up with extra funds or paying the early withdrawal fee. But, if you have your CD terms staggered, you can lock-in the new rate when one of your CDs matures.
You don’t have to worry about losing money by creating a CD ladder as long as you invest in CDs from an FDIC- or NCUA-insured bank or credit union.