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How to Build a CD Ladder

If you're looking to earn the highest possible yield on your investments without sacrificing the safety of government backed insurance, certificates of deposit are one way to go. By using a laddering approach with your CD purchases, you can take things up a notch, gaining even more from this already solid investment.

What is a CD ladder?

CDs typically offer higher interest rates than regular savings accounts in return for locking in your money for a set time period. The longer that maturity period is, the higher your earnings. However, if you put all your money in one long-term CD and interest rates rise before its maturity date arrives, you'll miss out on the chance to take advantage of those higher rates. Also, if an emergency comes up, you won't be able to access that cash without withdrawing the entire amount — and getting hit with penalties on your earnings.

Laddering is the perfect way to get around this dilemma. Rather than buying one large CD, this strategy involves purchasing multiple CDs with staggered maturity dates. That way, a portion of your cash is freed up each year for you to reinvest in another CD at current rates or use for other purposes.

A traditional CD laddering model

A classic CD ladder has five “rungs.” Each of these rungs represents a CD of equal value, and their terms are staggered so that one CD matures every year. For five years, for example, you could invest $5,000 this way:

  • $1,000 in a 12-month CD.
  • $1,000 in a 24-month CD.
  • $1,000 in a 36-month CD.
  • $1,000 in a 48-month CD.
  • $1,000 in a 60-month CD.

When the 12-month CD matures, you can then use that cash to purchase a new 60-month CD that will mature in year six, and continue this way so you get both the high returns that the longest-term CDs offer and the flexibility of having one-fifth of your investment freed up each year.

Other laddering approaches

Laddering doesn't have to be one size fits all. Those who can't tie up money for a whole year might do well with a four-rung ladder consisting of a three-month, six-month, nine-month and 12-month CD so that cash is freed up every three months. Or if you may need cash more frequently, build your ladder so that one CD matures each month.

Another thing to consider is changing economic projections. When times are uncertain, a CD ladder with equal rungs is the safest overall plan. However, if interest rates are clearly rising, you might want to invest a larger portion of your ladder fund in short-term CDs to take advantage of better offers as they become available. When interest rates are falling, it pays to invest as much as possible in long-term CDs, since you may not have an opportunity to lock in such good rates again for a long time.

CD ladder benefits

Whichever approach you choose, CD laddering offers a number of advantages over purchasing a single CD:

  • Higher income plus liquidity: Once your first CD matures, you'll enjoy long-term CD rates without giving up frequent access to your cash.
  • Flexibility: You'll be able to adjust your ladder to changing economic conditions and your individual financial situation.
  • Peace of mind: Whatever happens, you've got it covered. When rates drop, you've already locked in your return. And when rates rise, you'll have available cash to invest regularly.

Most financial experts agree that interest rates could be on the rise fairly soon, so it might be wise to build a shorter-term CD ladder to keep your options open.

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