How to Build a CD Ladder


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Emergency savings are essential for handling unexpected expenses or weathering uncertain situations like unemployment.

Still, almost 30% of Americans don’t have any form of an emergency fund and would need to borrow money to pay the bills if an unexpected cost hits them.

If you do have enough money to build an emergency fund, it can still be painful to set that cash aside. Interest rates are low these days, and most savings accounts pay almost no interest at all. 

Even online savings accounts tend to pay a rate lower than the rate of inflation, which means you’re actually losing money by keeping your cash in savings.

A CD ladder helps you remain flexible with your savings while eking out a bit more interest. They’re also helpful for people who tend to let money burn a hole in their pocket, making it hard to spend all of your savings at once.

What is a CD Ladder?

A Certificate of Deposit, or CD, is like a special type of savings account. When you open a CD, you select a term, such as six months, two years or five years. 

When you deposit money to open your CD, you make a promise to the bank that you won’t withdraw your money until the CD’s term ends. If you do need to withdraw money before the term ends, you must pay a penalty.

In exchange for your promise to keep your money in the bank for a set period, banks usually offer higher interest rates for CDs than they do for savings accounts. 

Another feature of CDs is that you lock in the interest rate when you open the account. By contrast, banks can change the interest rate on savings accounts whenever they’d like.

The restriction on when you can withdraw money from a CD can be a big deal.

If your car breaks down and you need to pay the mechanic bill, paying an early withdrawal fee to get your money just makes things more expensive. That’s where CD laddering comes in.

A CD ladder is a series of CDs with different maturity dates. As each CD matures, you have the option to withdraw your money or to roll the balance into a new CD.

This lets you retain some flexibility with your savings while getting the perks of CDs, such as the higher interest rate.

You can customize your CD ladder to your needs. If you need regular access to cash, set it up so one of your CDs matures each month.

If you can wait for longer between chances to make a withdrawal, you can have a CD mature quarterly or every six months.

Benefits of CD Laddering

Building a CD ladder has several advantages.

One is that you capture a higher rate of interest than you’d earn by putting your money into a savings account. Over time, it will leave you with more money to cover emergency expenses.

To illustrate the benefit of CD laddering, we will use Bank ABC (pretend) Saving builder that has an APY of 1.25%. And then we would compare that same bank having a CD APY of 1.30%.

If you have $10,000 to set aside, you can put it in a savings account and earn 1.25% APY. Over three years, you’d earn $379 in interest. 

If you instead set up a CD ladder using one year CDs, you’d earn 1.30% APY on your deposit. For three years, you’d earn $395. You’d get almost $100 more just for using a CD ladder.

Another potential benefit of CD ladders is that they make it more difficult to spend all of your money at once. If you tend to give in to temptation and spend your savings on wants rather than needs, a CD ladder locks your savings in the account. 

Having to pay a fee to make an early withdrawal can help reduce the temptation to spend your savings.

How to Build a CD Ladder

Let’s say you have $6,000 and want to use that money to build a CD ladder. And you want the option to make a withdrawal once every three months. 

To do this, you need to divide your $6,000 into four sets of $1,500. Then, open one three-month CD, one six-month CD, one nine-month CD and a one-year CD. Deposit $1,500 into each account. 

When your first CD matures, you can make a withdrawal. If you want to keep your CD ladder running, you should roll the balance into a new CD with a twelve-month term.

Once the first year elapses, you’ll have four CDs with twelve-month terms, with one maturing every three months. Every CD earns the interest rate offered on twelve-month CDs, but you retain extra flexibility.

Depending on your needs, you can structure your CD ladder however it makes sense for you. Maybe you only want access to some of your savings every six months, or you need the chance to make a withdrawal monthly. Using the correct combination of CDs lets you get the withdrawal frequency that you need.

Best CD Ladder Strategy for You

The best CD ladder strategy for you depends on your goals, resources and needs.

If you have a large sum of cash available, you can build a long CD ladder to take advantage of the interest rates offered by long-term CDs. Generally, long-term CDs offer higher APYs than short-term CDs.

For example, if you have $20,000 to set aside and want access to cash every three months, you can open eight, $2,500 CDs with terms ranging from three to twenty-four months.

Many banks have minimum balance requirements for their CDs, so it can be hard to open so many CDs if you don’t have a lot of cash on hand.

If you need frequent access to your savings, the best strategy might be to set aside money in a savings account. Then open a new one-year CD every month for a year. 

Doing this will let you access some of your savings every month and still give you the benefits of a CD ladder. The downside of this strategy is that it takes longer to set up the ladder.

If you highly value flexibility, you can use non-traditional CDs, such as no-penalty CDs to build your CD ladder. These let you make fee-free withdrawals whenever you’d like.

Alternatives to a CD Ladder

If you’re trying to set aside some extra cash, there are options beyond a CD ladder.

The simplest and likely most popular option is to use a savings account to hold your emergency savings. Online banks usually offer great rates for their savings accounts.

Many even beat the interest rates offered by CDs at brick and mortar banks. That can make them appealing for storing an emergency fund.

If you want more flexible access to your savings and potentially higher rates, you could instead open a money market account.

Money market accounts tend to have higher minimum balance requirements and fees than other bank accounts, but combine many aspects of checking and savings accounts.

Like checking accounts, most money market accounts give you the option to write checks against your balance. You can also get a debit card to make purchases or cash withdrawals from ATMs. However, there are limits to the number of transactions that you can make without incurring a fee.

Like savings accounts, money market accounts tend to pay interest. Depending on the bank, this rate could be lower, higher or similar to the savings account rate. 

Often, the interest rate you receive for your money market account increases with the balance of the account. This makes money market accounts suitable for people with large amounts to save.

If you’re willing to take on additional risk for potentially greater rewards, you could put your savings in a money market fund, a bond mutual fund or ETF. 

These types of investments involve risk, and you could lose money if the investment performs poorly. Still, you stand to earn far more than you’d receive from a savings account, money market account or CD ladder.

Summary

CD laddering is a strategy that enables you to earn a higher rate of interest while retaining the flexibility of using your savings for emergency expenses.

Deciding on the correct structure and setting up your CD ladder can take time but will pay dividends in the long run.