How (and Why) to Create a CD Ladder

Years ago, laddering certificates of deposit was a lot of work. Not only did you have to go down to your bank to open up multiple CD accounts, but your options were very limited. Today, online saving banks make it easy by offering the best CD rates with terms ranging from 3 months to 10 years, no-penalty CDs, and even rising rate CDs. And you can open a certificate of deposit online in minutes.

CD Ladders

So how does a CD ladder work? Put simply, a CD ladder is built by taking a lump sum of cash and investing it in a number of certificates of deposit that have different dates of maturity. By staggering the maturity dates, you are able to take advantage of better interest rates in the future without tying up all your money at one rate for a long period of time.

Most people who ladder CDs reinvest the principal when one certificate matures, thus preserving the ladder.

CD Laddering Example

Let’s look at an example. We’ll assume you have $20,000 to invest, you want CDs that mature one year apart, and you want to spread your investment evenly across each CD. So for this example, we’ll divide the investment into $4,000 increments, invested in one, two, three, four, and five-year CDs. Based on today’s interest rates, here’s what our initial investment would look like:

As the one-year CD matures, it should be rolled into a five-year CD. When the two-year CD matures, you roll it into a 5-year CD, and so on. Every year, you get your initial $4,000 back plus the interest it earned. Eventually, you’ll have five 5-year CDs, with one of them maturing each year.

Some certificates of deposit let you benefit from rising interest rates during the term of the CD.

The example we’ve used starts with CDs maturing every year, and builds up to a portfolio of 5-year CDs. There are many other ways CD laddering can work. For example, you could ladder your CDs so that one matures every three, six, or nine months. For a six-month ladder, just spread your initial investment across CDs maturing in six months, one year, 18 months, two years, 30 months, and so on up to 5 years. You’ll need to divide your money into more certificates of deposit (10 CDs rather than 5). But the benefit is you’ll have money at your disposal without penalty every 6 months.

Building a CD Ladder

To get started, you need to answer four questions:

1. How much money do you want to invest?
2. How much time do you want to put in between each CD's maturity date?
3. How much do you want to invest in each individual CD?
4. How soon do you want your first CD to mature?

A common approach is to use five CDs spaced one year apart. To do this, you would invest equal amounts in a 1-year, 2-year, 3-year, 4-year and 5-year CD. When the first CD matures 12 months later, you would reinvest the money in a 5-year CD. Then you would repeat this process over the next four years. The result is that all of your investment would be in 5-year CDs, with one maturing every year.

This same process can be followed with CDs that mature 6 months or apart.

One final thought. Several of the best online banks offer what is called no-penalty CDs. As the name suggests, you can withdraw your money anytime without paying a penalty (actually, you have to wait 7 days from opening the account to take out your money, but there’s no penalty anytime thereafter). I think the best offer available today is from Ally Bank, which offers an 11-month no-penalty CD with a very competitive interest rate.

This option works great in conjunction with a CD ladder. Rather than starting with a 6 or 12-month CD, invest some portion of your savings in the no-penalty CD option. From there, you can begin building longer-term CDs. With the no-penalty CD, you always have access to some portion of your money without penalty.