Climbing to Financial Success with CD Ladders

two ladders lean up against a wall

In today’s ever-changing financial landscape, finding reliable opportunities for steady growth and secure savings is crucial. This is where certificate of deposit (CD) ladders come into play. CD ladders are growing in popularity because they provide a balanced approach in building and managing your finances. But what is a CD ladder and how does it work? In this blog, we will discuss the essential features of this savings strategy, one rung at a time.

Reviewing the basics: What is a CD Account?

Before we explore CD ladders, let’s quickly revisit the basics of CDs (certificates of deposit). A CD is among the safest savings choices available, and it is FDIC insured. It works as a specialized savings account, holding a fixed amount of money for a specific period of time (spanning from a few months to several years). This duration acts as a lock-in period for your interest rates, ensuring that the returns are set throughout the investment term. While funds remain in your account during this timeframe, withdrawals are restricted. In return, when the waiting time is over (once the CDs reach “maturity”), you’ll receive your initial investment plus accumulated interest.

In other words, you deposit money into a bank account for a fixed length of time without touching it. Once the time is up, you can access your money again, but the amount of money has increased.

What is a CD ladder?

A CD ladder is a savings strategy where you invest several certificates of deposit with different maturity dates. Instead of putting all your money in one CD, you divide it across multiple CDs for different lengths of time.

This technique allows you to access and redeem your funds more often than if you put all of your savings in long-term CD, while still reaping some long-term and predictable benefits.

How do I build a CD ladder? How does it work?

To create the “laddering effect,” stagger the maturity dates based on your investment timeline and future needs for money access. As you build your ladder, keep in mind that your CDs don’t have to be the same amount, or even with the same bank or credit union.

Additionally, it’s important to note that you need a minimum of three CDs (or rungs) for a ladder, but a traditional CD ladder typically has five rungs spaced six months to one year apart. See below an example of a traditional ladder.

If you have $5,000 to invest, then it might look something like this:

  • CD #1: $1,000 with 1-year term at 5.25% APY → Reaches $1,052.50 at maturity
  • CD #2; $1,000 with 2-year term at 4.50% APY → Reaches $1,090 at maturity
  • CD #3: $1,000 with 3-year term at 4.30% APY → Reaches $1,129 at maturity
  • CD #4: $1,000 with 4-year term at 4.00% APY → Reaches $1,160 at maturity
  • CD #5: $1,000 with 5-year term at 3.40% APY → Reaches $1,170 at maturity

When the first CD matures after a year, you can either pocket the money or build the next rung of your ladder by reinvesting the funds into a new CD (in our example, this would be CD #6). Of course, you could do a combination of the two by pocketing the interest you have earned and then reinvesting the original amount with a higher interest rate. Once the two-year CD becomes available a year later, you can repeat the process.

In the above example, we reach the total at maturity by adding the original deposit amount and the interest earned. (Interest Earned = Deposit Amount x Interest Rate x Time)

Tip: Mark your calendar with each CD maturity date. Certain CDs may renew automatically, so it’s wise to plan ahead and decide how you intend to manage each CD when the time comes.

a graphic shows money growing over time
an image visually showing increase in growth

Pros & Cons of CD Ladders

Similar to any financial approach, CD ladders present a mix of advantages and disadvantages, many of which hinge on prevailing market rates.

Pros of CD Ladders

  • Low risk: A CD ladder is a safe investment choice. Unlike stocks and other investments, CDs are not affected by market ups and downs, making them a reliable option in uncertain economic times. They are also FDIC-insured, guaranteeing your money is protected.
  • Take advantage of high rates: This savings strategy gives you the ability to make the most of strong rates as they become available in the market instead of missing out or waiting for your money to mature in a single CD.
  • Steady & Predictable: Because CDs offer a guaranteed rate of return, CD ladders can help you create a reliable source of investment returns while providing a steady flow of savings over time.
  • Increased liquidity: CD ladders offer quicker access to your cash than if you were to lock all your money into one CD. You also get to decide how and when to reinvest (or use) your money on a more regular basis.

Cons of CD Ladders

  • Early withdrawal penalties: If you need to pull your funds from a CD earlier than its maturity date, you will face penalties and be charged a fee.
  • Rates can and will change: If interest rates rise significantly after setting up a CD ladder, you might miss your chance to invest in higher-yielding CDs because your funds are already locked into lower-rate CDs. (However, depending on the timeline of your staggered maturities, hopefully one of your CDs will come available when there are high rates).
  • Potential for declining rates: When your CD matures and is ready to be reinvested for the next round, the interest rates might be lower than they were when you initially started the ladder. In other words, unless your rates are locked in, the rates in your ladder are at the mercy of the market’s current rates.
  • Tax implications: The interest earned from CDs is generally subject to income tax, potentially reducing your overall after-tax returns.

Current financial climate

The interest rate landscape will always be unpredictable. Rates are currently high, but their path over the next five years remains uncertain.

However, one thing is for sure. If the United States enters a recession, the Federal Reserve will have to lower interest rates. Our advice is to take advantage of the high interest rates while they are still here. By locking in great rates today, you can guarantee reaping some long-term, predictable benefits.

So what?

A CD ladder blends the convenience of access with the potential for greater earnings, making it’s a smart choice for anyone aiming to manage short-term needs while securing long-term financial stability. Not only does it create a dependable way to capitalize on current financial opportunities, but it also offers an adaptable approach in navigating potential in interest rates or economic conditions. In essence, a CD ladder provides you with a proactive way to grow your assets, today and tomorrow.

Ready to start planning your CD ladder? Use resources like our CD Ladder Calculator to get started.

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