CD ladders: What you need to know

When I begged my parents for my first CD when I was 12, they figured I wanted to spend my allowance on music like the rest of my friends.

But what I was really asking for was a certificate of deposit from the bank.

Back then, it was a great investment. The CD paid about 5% interest, which was way more than my savings account was paying at the time. I couldn’t touch the money for a whole year — but because I was a kid with no bills to pay, I didn’t have to worry about needing the cash for anything immediate.

These days, certificates of deposit are, to me, about as outdated as compact discs. They just don’t make sense for my situation anymore. As an adult, I need easier access to my money so I can pay my monthly expenses.

That’s where CD ladders come in. These financial instruments combine multiple CDs with different maturity dates, so you can enjoy the higher interest rates you’d expect from a certificate of deposit with the liquidity you get from a savings account.

Let’s take a closer look at how CD ladders work and when you might want to consider building one.

• What is a CD ladder and how does it work?
• What are the pros and cons of a CD ladder?
• How do I build a CD ladder?

What is a CD ladder and how does it work?

A CD ladder is a series of certificates of deposit with rotating maturity dates.

Instead of locking up all your money in one CD, you spread it out across multiple CDs with staggering term lengths and interest rates.

When a CD matures, you can reinvest your money by electing to automatically roll it into another long-term CD where it goes to the back of the line, while the other CDs move up in line. This cycle is known as the “laddering effect.”

This technique is a more secure, steady way to grow your savings — and you still get access to your money periodically when each CD matures, just in case you need it for some reason or want to switch to a higher-earning investment.

What’s a mini CD ladder?

A mini CD ladder works the same way, but the individual CDs mature at a faster pace in a matter of months, instead of on a yearly basis.

Because you can customize your CD ladder, it’s up to you to pick the different term lengths and maturity dates that work for your schedule. If you’re expecting interest rates to go up in the near future, or think you might need the money soon, you could opt for a mini CD ladder.

This gives you easier access to cash without being charged an early-withdrawal penalty for taking your money out early.

What are the pros and cons of a CD ladder?

Let’s take a look at the advantages and disadvantages of a CD ladder to see if it’s right for you.

Pros of a CD ladder

CD ladders can combine higher interest rates with easier access to your money. In general, fixed-rate certificates of deposit can be good investments when interest rates are declining because they lock in your rate.

Cons of a CD ladder

Building a CD ladder with short-term accounts can help minimize the protection certificates of deposit provide against declining interest rates. Because as your CDs mature, you could be forced to reinvest them at lower rates. And when rates start to go back up, you might regret being stuck with a lower return. Also, if you do need to pull your funds out of a CD early for some reason, you will likely pay a penalty for early withdrawal.

Are CD ladders a good investment?

Before you decide to start a CD ladder, consider your personal investment strategy.

Certificates of deposit can offer stable interest rates, so they’re good investments when rates are spiraling downwards. But they’re not such a great choice when interest rates are rising because you’re locked into a lower rate (if your CD has a fixed rate).

If you’re looking for a safe place to park your savings while maximizing returns, certificates of deposit typically offer higher interest rates than traditional savings accounts from brick-and mortar banks. But even if you build a CD ladder with varying expiration dates, it won’t provide quite as much liquidity as a checking or savings account — you still have to wait for the short-term CDs to mature periodically.

CD ladders can also be a lot of work to maintain. You have to stay on top of rolling over your expiring certificates into new accounts — while juggling many different dates and rates. And even if you set up automatic rollovers, you’ll want to do your research before the rollovers happen to make sure you’re getting the best rate possible. If you’re not willing to put in that much effort, you might be better off with a high-yield savings account or rewards checking account, both of which could offer more frequent access to your money — and potentially better returns.

How do I build a CD ladder?

There’s no single perfect CD ladder strategy for everybody. You can put your money in a mix of short- and long-term CDs that best suit your investment time frame and your need for income and liquidity.

Here’s one example of how to create a CD ladder.

Step 1: Open the CDs

Let’s say you have $20,000 to invest. How do you want to split up the money? For this example, you decide to divide your money into four equal parts and open four CDs at once. To set up the “laddering effect,” stagger the maturity dates so they align with when you need the money: 

CD 1: $5,000 in a six-month CD

CD 2: $5,000 in a 12-month CD

CD 3: $5,000 in a three-year CD

CD 4: $5,000 in a five-year CD

Finally, mark your calendar so that you know when each matures. This gives you plenty of time to make a decision about reinvesting the money or cashing out. 

Step 2: Reinvest the money

Here’s the “hands-on” part of building a CD ladder. As your CDs mature, the bank may give you a grace period in which you can withdraw money, add money or change the term. Instead of just letting your CD roll over, look around for a new CD with a better rate. Longer-term CDs, such as five years, often get higher returns.

Step 3: Repeat or cash out

Every time a CD becomes due, ask yourself whether you need the money for one of your financial goals — or whether you can roll all (or part) of it into a longer-term CD at a higher interest rate. If you determine the money is better invested elsewhere, then cash out the CD and put it elsewhere. Otherwise, be sure to shop terms and rates for an option that works for your goals.

What’s next: Other ways to earn higher interest

That CD I opened when I was 12 might have taught me the value of saving patiently. But if I had to do it all over, I’d use that money to buy shares of tech stocks or even an index fund like the S&P 500, and I might be a millionaire by now.

My point is that even if your CD pays a higher interest rate than most savings accounts, the rates are lower than they used to be. So if you’re saving for the long term, you might as well pick a higher-returning investment.

On the other hand, if you’re saving for an emergency, you should pick a bank account that offers more liquidity.

Fortunately, you might be able to do both. There are plenty of FDIC-insured bank accounts (for people who don’t want to risk their money on the stock market) that pay interest rates that are competitive with CDs while giving you better access to your money. Here are a few examples.

• High-yield savings accounts
• Rewards checking accounts
• Money market accounts