How to Build a CD Ladder: A Smarter Way to Save

How to Build a CD Ladder
Today I will explain how to build a CD ladder (i.e. certificate of deposit ladder) to create some passive income. In short, a CD ladder is a group of CDs you might invest in that are set to expire at successive dates.

Cash from an expiring CD is used to reinvest in another CD one period older than the oldest CD currently in the ladder.

The CD Laddering Strategy Explained

Okay, here’s how you build a CD ladder. You’ll first need to determine what type of ladder you’ll want.

Does this ladder have big rungs (yearly) or many smaller rungs (monthly)?

If the maximum you can bear is without all your funds in 1 year, then a monthly ladder is right for you. If this money is just extra savings you don’t mind waiting five years on, you can do the yearly ladder.

This may be a good option for ultra-risk-averse people who don’t want to be in the turbulent stock market.

CD Laddering Example

For our example, let’s say you select yearly. It’s the quickest to set up, anyway.

Do some research and find the highest-paying CDs. Raisin has a nice list. They have a 5% rate CD.

Divide your savings into 5ths and purchase the 5 CDs with 1/5 of the money each. Your CDs will look something like this (let’s say you invest $5,000):

  • 5-Year CD – $1,000 @ 4%
  • 4-Year CD – $1,000 @ 3.5%
  • 3-Year CD – $1,000 @ 3.0%
  • 2-Year CD – $1,000 @ 2.5%
  • 1-Year CD – $1,000 @ 2.0%

At this point, you can sit back and relax, knowing your money is earning you decent, inflation-busting interest and it is guaranteed by the bank issuing the CDs.

After one year, your accounts will look like this if you continue the ladder strategy:

  • Newly purchased 5-Year CD – $1,000 @ 4%
  • 5-Year CD (now only four years to mature) – $1,000 @ 4%
  • 4-Year CD (now only three years to mature) – $1,000 @ 3.5%
  • 3-Year CD (now only two years to mature) – $1,000 @ 3.0%
  • 2-Year CD (now only one year to mature) – $1,000 @ 2.5%
  • Matured (and cashed out) 1-Year CD – $1,000 @ 2.0% 0 Cash is used to purchase a new 5-year CD.

Thus, the rotation of the ladder begins.

You’re expiring cash is used to purchase a new 5-year CD. Therefore, at the end of five years and five maturity and purchase combinations, you’ll have nothing but 5-year CD rates in your ladder.

Safe, secure money, paying an excellent, high rate of return, maturing in one-year intervals. Woohoo!

Benefits of a CD Ladder

As you can see by how CDs work and by the strategy, there are many reasons you’d want to have a CD ladder:

  • CDs are FDIC insured up to $250,000. Your money isn’t going anywhere. You can’t touch it till the CD matures.
  • CDs pay interest rates slightly above their online, high yield savings account counterparts. And as mentioned above, the longer the maturity level, the higher the rate.
  • Eventually, you’ll hit the sweet spot (when your initial oldest CD becomes mature) and start seeing long-range CD rates maturing one after another. I’ve never done this, but it’s got to feel great when you get to this point. Always a high-interest rate.
  • The CD ladder shines when rates are dropping. While the current market offers lower rates, you still earn high interest. Rates may drop soon, so get to building your ladder.

Risks of a CD Ladder

There are some things to watch out for when building a CD ladder:

  • You may be paying a hefty penalty if you withdraw money from a CD before its maturity date, leading to significantly smaller returns than initially planned.
  • A rise in the interest rate during the term of your CD can cause your anticipated earnings to fall short.
  • Your investments may not match the growth of inflation, leaving you with fewer funds after investing in multiple CDs for an extended period.

How to Calculate Your CD Ladder Earnings

The formula to calculate your earnings from a CD Laddering strategy is as follows:

Earnings = Sum of Interest Earned + (Principal Amount * (1 + Effective Rate) / 2)

Where Interest Earned is the interest earned on each CD and Effective Rate is the weighted average of the rates offered by all CDs combined.

The effective rate is determined by taking an average of the interest rates offered by all of the CDs combined. This can be calculated using the following formula:

Effective Rate = (CD1 ‘s Interest Rate + CD2’s Interest Rate + …+CDn ‘s Interest Rate)/n

Where n is the number of CDs in your portfolio.

What are Certificates of Deposit?

As a quick refresh, Certificates of Deposits, or CDs, are a short-term investment product most banking institutions offer.

They’re sort of like a savings account, except they are not as liquid and pay a nicer, fixed interest rate.

Liquid means how easily you can get your money out or how “available” your money is. CDs have a designated maturity date and don’t become liquid until the period expires (matures).

This is why they can pay a higher interest rate than a typical savings account. You’re simply trading liquidity for higher interest.

Higher interest is, of course, what we all want.

But we each have different needs when it comes to liquidity.

Some need their money next month.

Others don’t need it for a couple of years. Those that don’t need it for several years will reap the benefit of a higher interest rate.

But, as you’ll see with laddering, you can eventually have high rates and liquidity. Good things come to those who wait.

Are CDs and Laddering a Good Retirement Savings Strategy?

If you are close to retirement, likely.

Most financial advisers recommend choosing a more risk-adverse path towards retirement as an individual ages. And therefore, may not necessarily recommend bank deposits to those who are fresh out of school and beginning to enter the workforce.

However, those portfolios that have already had decades of growth under their belts, can look to protect the returns already garnered through federally insured investment vehicles which don’t expose the principal to any risk.

This isn’t too say bank CDs (even in a positive interest rate climate) should ever make up a majority of overall assets, but they should hold a generous portion of the asset section allocated to cash.

Where to Build a CD Ladder

There are many options when it comes to CDs. CD maturity dates range from 1 month to 5 years. Typical offerings come in the 3-month, 6-month, 1-year, and 5-year variety.

There are also “no-penalty CDs,” where you can withdraw your money early without penalty.

Which CD is correct for you can depend on many factors. The greatest of which, mentioned above, is your need for liquidity.

You can build a CD ladder at most banks that have CDs as an option. Start with your own bank and see what they have available.

Some of the best CD rates can be found at Raisin, where you can access CDs from multiple banks and credit unions under one account.

See our Raisin review to learn more about their different CD offerings.

More CD Rates


Watch Out for Early Withdrawal

But what happens if you withdraw your funds from a CD early? This is a no-no unless necessary.

You will likely have to pay the penalty and/or lose some of the interest you earned if you cash in your CD too early.

FAQs About CD Ladders

How do I choose the terms for my CD ladder?

The terms you choose for your CDs should be based on personal preference and financial situation. Generally, it is recommended to spread out the maturity dates of each CD equally over one, two, or three years.

You can also choose different maturities if your circumstances require it, such as expecting a large windfall or needing more access to funds shortly.

What type of rate should I expect when building a CD ladder?

The interest rate you receive depends largely on the length of the term of your CD, with longer-term CDs offering higher rates than short-term CDs.

However, interest rates and yields change often, so it’s best to check regularly to ensure you’re getting a competitive yield on your money.

How do I know if a CD ladder is right for me?

Building a CD ladder may be right for you if you’re looking for a safe and dependable way to save money while still earning competitive returns on your investments.

It also works well if you need access to some of your money but want the highest interest rate possible.

However, this strategy may not suit you if you’re looking for short-term investments or don’t need regular income.

Can small business owners do CD laddering?

Saving in multiple CDs with different maturity dates is an ideal option for businesses looking to keep their cashflow steady and earn higher returns on their savings.

CD Laddering allows businesses to access their savings when they need it, while still capturing better rates of return than a single CD can offer.

Do you have a successful CD ladder? Should you build one now?

Avatar About Philip Taylor, CPA

Philip Taylor is a CPA, writer, entrepreneur, and founder of FinCon. Philip has been quoted and featured in multiple media outlets including The New York Times, The Washington Post, Forbes, Fox Business, and more. Connect with him on Twitter or LinkedIn.

Comments

  1. i have always wanted to do this but was never given the full strategy. i hear all of your complaints. what are some alternatives? thank you pt this is a great article.

  2. Avatar Brad Chaffee says

    Aren’t CD’s just a plain old waste of time? Why would I invest in a CD to expect the highest likely return of 4%. After taxes and inflation don;t I need to make about 5%-6% just to break even?

    Now I guess I understand it for savings, but I still do not think I would choose that method. If I am going to save for something to be used after 5 years, I will just use a mutual fund.

    Right now ING is offering 1.65% on their electric orange checking. 1.5% with a CD for one year.

  3. Avatar MITBeta @ Don't Feed The Alligators says

    I use a CD ladder for our emergency fund. It’s just enough out of reach to keep me from temptation.

    I know you guys all know that personal finance isn’t all about math…

  4. Avatar My Journey says

    PT lets go with the $50K in savings, if they have a 20% effective tax rate they are looking at 640 net. That is 53 bucks or so a month. I don’t think I’d tie up $50K for 1 year at a time (or I guess it would be 10K but still same argument) for an extra 50 bucks a month.

    The question I guess that is more important, would you tie up that kind of liquid cash for an extra 50 bucks?

  5. Well, I think I got my answer. Its just not worth it. I actually opened up a 6 month CD at a different bank than ING at 2.25% a couple of weeks ago because I got an unexpected bonus at work and wanted to make sure I didn’t spend the money. I wanted to take 6 months to decide what to do with it (save it or pay off my husbands car). I like the strategy of the 1 year cd every week thing but that is a lot of work and my time is limited with working almost full time and having 2 year old twins!

  6. Before I bought my house in February (which has been kicking my butt, BTW), I had started a different type of ladder through ING. On every day of the month divisible by 7 (the 7th, 14th, 21st, and 28th), I was opening small 1-year CD’s. In a year, I could decide to take that money and cash out or re-up, and leads to a CD maturing every week. Then the CD rates matched the savings, so I halted. Just another strategy to consider.

  7. Avatar Jules @ Lovely Las Vegas says

    Great post, PT Money. I like CDs and the laddering scheme, but until things are a little more bright with the economy, I’m not going to put more money into them. I have one CD coming due soon but will just funnel it into the emergency fund for a little extra cushion. True, I could be earning more by creating a new CD ladder scheme, but I prefer the added liquidity now. Plus once rates are on the increase (and I feel content with my normal emergency fund amount), I can lock the extra money into the new, higher interest rates for CDs.

  8. @Lynn – that’s an excellent point. can the savings vs long-term CD rate ratio tell us about the market’s direction? or at least does it tell us what the banks are thinking?

    @My Journey – there is definitely a break even point to consider. and online savings accounts haven’t helped out the CD product from a marketing perspective.

    I think anyone with only $5000 to put in should stick with FDIC insured online savings. Once you get into the 50K range, when that $80 you mention becomes $800, I would think it starts becoming worth it to go with CDs.

    But then again, not everyone is going to have 50K in cash savings. We should all be so lucky, right?

  9. I really would like to start a CD ladder for my twin daughters. We have about $3000K saved up for each of them and it is just earning the pathetic 1.5 % interest in ING. I actually logged into my account on Monday and the CD rates are equal or less than the savings account. I was shocked. What’s the point of tying up your money if the interest is less? Does this mean a rate redution for the ING savings accoung is coming?

  10. Avatar My Journey says

    “Still, CD rates are largely better than high-yield savings accounts, so it might still make sense for you now.”

    PT,

    I went back and forth with Kevin from No Debt Plan on this issue like 9 months ago…

    http://www.myjourneytomillions.com/articles/are-certificate-of-deposits-cds-worth-it/

    I did the math – the interest rates were MUCH higher then, but I think the truth still stands, that the extra money made from this set up isn’t worth the loss of use of the cash involved?

    Check out the math let me know what you think? But for instance,
    Lets say your $5,000 is making 2% in an online savings account – you have $100 pre-tax or $80 post tax (assuming a 20% effective tax rate) for the year.

    VS.

    $5000 in your CD Ladder and giving you the benefit of the doubt of an effective return of 4% (just taking the higher number) you will have earned $200 pre tax for the year or $160 post tax for the year.

    My point is that for an “extra” 80 bucks for the year (6 bucks a month) is it ‘worth’ to keep your money locked up?

    Yes, you can access it for emergencies but almost ALL of the 80 dollar gains would be gone.

    Thoughts?