If you’re looking for a reliable, low-risk way to earn on your savings, a certificate of deposit (CD) ladder offers both long-term interest rates with steady returns. As the Federal Reserve continues to raise interest rates, cash accounts like these become even more attractive as they see record-high returns. Still, it’s important to keep in mind that a CD ladder is not an alternative to an investing strategy because inflation often outpaces even the highest of yields.
What is a CD ladder?
A CD ladder is a savings strategy in which you open multiple CDs at different intervals. CD ladders have the benefits of higher interest rates that come with long-term CDs while also having access to cash. Each CD, which are the “steps” that are integral to a CD ladder, is a fixed deposit that earns interest over a specific period.
What makes CDs different from high-yield savings accounts is that the deposit can’t be withdrawn or adjusted during the term or you could face fees and loss of interest. While there are some CDs that don’t carry early withdrawal fees, they tend to have much lower interest rates.
Bump-up CDs are a kind of CD that allows you to adjust the CD’s interest rate once during the period the deposit is maturing. “The [way these work] is that you put the money in and it might be paying 3% or 4%, but if the interest rates jumped to 5% or 6% during your term, you can contact the bank and increase your interest rate in the middle of the term,” says Brent Weiss, a certified financial planner and founding member of Facet.
How CD ladders work
CD ladders work by giving investors staggered returns as the CDs expire one by one. This way, investors can get the benefits of CDs while still getting regular cash yields.
What makes CD ladders effective is that savers have the benefit of longer-term interest rates that are locked in for a set period of time, as well as cash returns since the different CDs are expiring in succession. You could build one CD ladder for a set expense you know you’ll have in the future, such as a car payment or tuition bill, and cash out when the big day arrives. Or, you could also reinvest the money when each CD matures into a new certificate at the best CD rates available at the time, creating an ongoing ladder.
It is important to keep in mind that while CD ladders are a great way to take advantage of high-interest rates, they’re not considered a long-term investment strategy. For goals like retirement savings, a Roth IRA or a 401(k) that invests in equities in the stock market are the best choices. “A major point I want to reiterate is that a CD ladder shouldn’t be an alternative to a longer-term investment or wealth-building strategy,” Weiss explains.
How to build a CD ladder to get staggered returns
The key to building a successful CD ladder is staggering your investments in CDs so that they mature in succession, but not at the same time. For example, if you have $2,500 to invest, you could invest in five CDs that range from one-year to five-year CDs. When one CD matures, you can cash it out and reinvest the money in a new CD that matures however many years away you want to continue the ladder.
If you are new to investing in CDs, shopping around different financial institutions for the best interest rates is a great way to make the most of your CD ladder. Weiss explains that he usually advises his clients to have relationships with at least two different banks so that if one bank has issues they still have an institution available to draw cash from.
The takeaway
CD ladders can be a great strategy for those in retirement or anyone looking to see steady returns in a low-risk, safe savings method. “I always tell my clients, don't just chase the rates, follow your plan and define what you're trying to achieve when putting money either in a high-yield savings account or buying CDs,” Weiss explains. “Make sure that your plan fits what you're trying to achieve in your financial situation.”
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