What's a CD ladder? Is it worth it?

Looking for different ways to grow your money? Then you might have heard of CDs or maybe even a CD ladder strategy. They may seem complicated at first, but simply put, a CD ladder strategy allows you to earn interest that CDs provide, while maintaining access to your money. The best of both worlds. 

Choosing a CD ladder allows you more flexibility with your savings by investing in multiple CDs, all while earning guaranteed interest rates.¹ So let’s break down this investment strategy and get to the bottom—or top—of a CD ladder.

CD stands for certificate of deposit. It’s technically the receipt (certificate) you get when you put cash (deposit) into a special account. It’s that account, where your cash grows, that people typically refer to when they say they’re “putting money into a CD.”

CDs are a win-win-win for customers, banks and borrowers. When customers put their money in a CD, they are guaranteeing a set amount of time the bank can access these funds. This is great for banks who now have funds to give to borrowers who want or need loans. Because CDs promise money to banks for a set amount of time, they often have higher interest rates than savings accounts.² This time limit is a key component of a CD. You usually can’t withdraw your money for the length of the CD without paying a penalty (typically a percentage of the interest you’ve earned).² For some, this is no big deal. For others who want more flexibility, this time commitment can be a drawback.

How long do CDs last? That depends on the time frame (term) you choose when you first open a CD. Typically, it can range anywhere from a 6-month to 5-year CD or beyond based on the time commitment and interest rate the investor wants.³ Of course, the longer your cash is in a CD, the more money the bank pays you in the form of high-interest rates and compounding interest (when the money earned by interest earns its own interest).⁴ The longer the term, usually, the greater potential for cash savings. And when your CD term is up, you’re free to transfer your money to whichever account your bank allows, renew the CD or reinvest it elsewhere.

Here’s where you’re probably starting to see a problem. “You mean I can’t get my own money without paying a fee? What happens if things change and I need it now? Or have a better investment opportunity?” Enter the CD ladder strategy. A CD ladder strategy allows you to get higher earn rates in the short term while still allowing for long-term flexibility with your money in case of emergencies or better investment opportunities.

Pretend there’s a ladder in front of you and each rung represents a separate CD with a separate term. The rungs start from the shortest term (the bottom rung) to the longest term (the top rung). Now if you wanted to start just one CD, you’d put your money on just one rung of the ladder. Let’s say you choose a 5-year term, or 5 rungs up the ladder. Each year, you’d take a step up the ladder until you finally reach the rung your money is on in 5 years. But remember, that means your money is in the CD for the full 5-year term unless you withdraw it. Over these 5 years, your money will have grown a lot—the whole time you were climbing.

But what would happen if you put a little money on the first rung so you could reach it in a year? Then took a little more money and put it on the second rung to reach it in 2 years? And another on the third rung? You’d have regular access to your money even as the other rungs still continue to earn. That’s how you build a CD ladder.¹

So let’s say that you have $40,000 to invest. If you put that into a single 5-year CD, you might earn a better rate, but you’re also giving up flexibility over your funds.

Instead, if you break that amount down into 4 rungs (1st, 2nd, 3rd and 4th) of $10,000 each, representing 4 different terms (1-, 2-, 3- and 4-year CDs). 

As you reach each rung, you have the option to cash out your CD or renew it again and move it to the top of your CD ladder for a later cash-out date. You can also combine these options. For example, after Year 1, when your CD is up, you decide to take $2,000 out for a vacation and personal savings. But you also choose to renew your CD with the remaining funds for an additional 4-year investment. This means you are enjoying some of your money now and some of it you will see again in Year 5.

When you create a CD ladder, you’re able to access part of your investment each year while the remaining CDs are actively making money. After each CD comes to term, you can keep adding on to your CD ladder—even well into retirement. For example, that same $40,000 could be split up into 10 CDs, with $4,000 in each, and set to mature every 6 months over the next 5 years.

While a CD ladder strategy works for some people, it won’t work for everyone. It all comes down to how you feel most comfortable saving. Some things to consider:

• You can’t change rungs once you put your cash down. If something happens where you need your money before the CD term is up, you may have to pay penalties for taking it out early.³ If you need even more flexibility and access than a CD ladder can provide, a savings account might be more your style.
• On the other hand, CDs are typically FDIC insured, meaning your cash will be covered up to the limits you qualify for. And since you lock in your interest rates, a change in the economy or outlook from the Fed won’t affect your future savings.³

Because there are so many different choices with CD ladders, your best option might be to check with your personal financial advisor to see what opportunities are available and which CD ladder strategy (if any) is right for you. Remember, no matter where you end up investing, set your savings goals high so that you’ll need a ladder to reach them.