How to ladder CDs

Picture of a toolkit for an article on laddering CDs

How to build a CD ladder? It's a great question — unless you have no idea what a CD “ladder” even is. Let's start at the beginning. A CD ladder is a method of staggering the maturity dates of certificates of deposits so you can invest your money safely and still keep some of it easily available for emergencies.

The Federal Deposit Insurance Corporation (FDIC) insures certificates of deposit (or time deposits) just like they insure savings accounts — so they are just as safe.

However, CD rates are higher than a savings account rates because of the reduced liquidity — you have to tie up your money for a period of three months to six years. Of course, these being the dog days of quantitative easing, those higher CD rates can still be counted on very few fingers of a single hand.

And so you wonder: Could there be a way around that, a way to capture a higher CD rate without having your money in a prison cell for which they have thrown away the key?
The CD ladder is the way around that liquidity problem.

The Ladder's Interesting History

The concept of laddering originated in the arena of bond investing. (In case you are wondering, more money worldwide is invested in bonds than any other investment vehicle, and it isn't even close.)

Related >> Todays CD Rates

Each bond has a fixed maturity date. (A bond is simply a loan, for which interest is paid quarterly and the original principal gets repaid in a lump sum at some point in the future, called the maturity date.)

As an example, IBM Corporation has 10 different bonds outstanding today, maturing in September 2017, February 2018, October 2018, and so forth, all the way up to November 2025. As a bond investor, you would receive an interest check every quarter, but you wouldn't get your money back until that bond's specific maturity date.

You can sell your bonds on the open market, pretty much like mutual funds and stocks, only the process is not nearly as efficient (or cheap), and the amount you get from the sale may be far different from the maturity amount.

Bond investors, therefore, developed a strategy called laddering or layering. In a nutshell, laddering involves buying bonds with staggered maturity dates. This strategy gives you a steady stream of maturing bonds rather than a single, big sum tied up until some date far into the future.

Well, in some ways, certificates of deposit (CDs) function like bonds held to maturity and, therefore, it is no surprise that laddering became a viable strategy to help maintain some access to the amounts on deposit in CD investments as well.

The Benefits of Laddering CDs

Why has laddering become such an established strategy to invest in bonds, CDs and other investments with fixed interest rates and fixed maturity dates? Here are some of the benefits:

1. Great liquidity: Once you are up and running (explained more in the example below) you will have investments maturing on an evenly spread out timeline. That eliminates the dilemma of not being able to get at your money should something unforeseen happen. Should you not need the money, you simply “roll over” the investment, tacking the money back on the end of the ladder, so to speak.

2. Higher return: You get higher CD rates the longer you are willing to tie up your money. With a ladder, you will end up having a string of max term/max yield CDs, which still mature each quarter (or whichever period you choose to have them mature).

Great flexibility and great returns — relatively speaking, of course — how can you beat that?

In addition, there is another subtle benefit CD ladders offer:

3. Coverage against interest rate risk: If there is one thing you know by now, it's that CD rates fluctuate constantly. They never stay the same. In a climate of dropping interest rates, staggering the maturity dates of your CDs will protect you by allowing you to capture interest rates on your rollovers before they reach the low point of your last rollover. Likewise, when interest rates start rising again, you won't have to miss out while your investment is stuck in a single, low-interest-rate CD.

An Example of How to Ladder CDs

Let's say you have $20,000 to invest and you decide you want to have access to some of the money once a quarter, at which time you have the option of withdrawing it with no penalty or rolling it over into another CD.

You can choose the maturity date (sometimes referred to as a liquidity event) of a certificate of deposit. They are typically offered in three-, six- and nine-month maturities, followed by one-, three- and five-year maturities. The longer the period, the higher the yield. A three-month CD might yield 0.3 percent while a five-year CD may yield 2.0 percent. The difference between these maturities is the price you pay for the liquidity you want. (CD rates change all the time, so the numbers used in the example might be different for you. However, the relationship between the various numbers generally holds true, no matter the prevailing rates. Therefore, consider the rates in the example in relative, rather than absolute, terms.)

Option A: Unladdered CDs

If you want the benefit of a quarterly liquidity event, your first instinct may be to simply open a three-month CD for the total amount. Then, every quarter, when the CD matures, you reinvest it (roll it over). In this example, your yield would be 0.3 percent per year, or $15 per quarter, $60 per year, and $300 over a five-year period.

Option B: Laddered CDs

To start a CD ladder, you would invest $1,000 in a five-year CD and deposit the remaining $19,000 in a three-month CD.

At the end of the first quarter, you would invest $1,000 in the second five-year CD and roll over the remaining $18,000 for another quarter.

At the end of the next quarter, you would take another $1,000 and put it in another five-year CD and roll over the rest.

You continue with that until the 20th quarter, when all $20,000 will be invested in 20 different CDs, all with the maximum (five-year) maturity.

At the end of the 21st quarter, the very first five-year CD will mature, and you would have the choice to withdraw or roll over the money into another five-year CD.

From then on, you will be earning the maximum CD return on every one of your 20 CDs — and you will still have $1,000 maturing every quarter.

Comparing Your Options

Using the numbers in the example, Option A will earn $300 in interest over the first five years, while Option B (the ladder) will earn just under $1,200 — almost four times that amount!

This is a simple example. You could make the difference even greater by investing some of your money in intermediate term CDs while you wait for those amounts to be invested in their proper “rungs” of the ladder, but that complicates the calculation without changing the point. The improvement laddering offers over simple CD investing depends on how frequently you need a liquidity event. (The longer you can wait, the less of a difference you would get.)

The underlying point remains the same, though: Laddering your CDs can offer significantly better returns than simple CD investing.

Do you use certificates of deposit as a safe investment? Do you use a CD ladder to profit from interest-rate fluctuations?

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Bill
Bill
5 years ago

I took this approach using US Treasury I-bonds. While the rate can change every quarter, it has been consistently above what CDs have offered for the past few years.

I started with $10,000 and bought a new $1000 I-bond through TreasuryDirect each month. This investment is the backbone of my emergency fund, so if something befalls me that will take longer than the $2000 or so I have stashed in a savings account will last, then I can easily sell back these bonds with interest.

Bill
Bill
5 years ago
Reply to  Bill

I should caution readers though that there are other limitations to Ibonds, such as a 3-month interest penalty for cashing out before 5 years; and a mandatory hold for the first year (can’t cash out for one year from the buy date).

Oh, and a correction: the rate changes every 6 months, not every quarter.

Justin
Justin
5 years ago
Reply to  Bill

I recommend this approach with annuities, you get a higher yield, deferred taxes which could lead to less social security taxes (think increased spendable income) and a higher balance at the end of each ladder expiration.
I am a fan of using a MYGA (5-7 years), a 10 year surrender indexed annuity that has a bonus to contributions and locks in any participating gains in the S&P500 (or other index) which avoiding falls in market value.

Kevin
Kevin
4 years ago
Reply to  Justin

Justin anyway we can discuss this more sounds like exactly what I want to do.

Aldo
Aldo
5 years ago

Interesting. This sounds like a good strategy, but instead of getting a 3-month CD, which pays less than 0.5%, I would keep the remaining money on my credit union, which pays 0.90% and my money is not tied up.

The strategy is still sound.

William
William
5 years ago
Reply to  Aldo

You’re right. However, we didn’t want to distract from the main point of the post, which is the technique of laddering itself.

There will be times when banks will offer better rates on instruments will total liquidity than on short-term CDs. When you see that, it obviously makes sense to take advantage of those.

The main idea, though, was to highlight the logic of laddering, something many people overlook.

Thanks for bringing that up, though. 🙂

Valerie
Valerie
5 years ago

Thanks for this! We were just having a discussion on ways to invest emergency savings so they’re working for you but still easily accessible.

Wiggles @FirstYouGetTheMoney
Wiggles @FirstYouGetTheMoney
5 years ago

What a great savings “hack”. A nice strategy to maximize earnings while keeping your investment safe.

Nick
Nick
5 years ago

If I take the example above: A “mature” CD Ladder (i.e. one after the 20th quarter that is invested all in 5yr CDs) will earn me 2%. However, your effective interest rate for that first 5 years will be much less than that because it will be dragged down by all of the 3 month CDs you open only earning 0.3%. The math to figure the exact interest rate is too complex for me, but I do know it would be less than 2%. The closer it gets to 0.9-1%, the more sense it makes to go with the online… Read more »

William
William
5 years ago
Reply to  Nick

You’re right. However, laddering offers more liquidity for the first 5 years, and the lower interest during that period is the price you pay for that liquidity. Given the greater liquidity of laddering during those first 5 years, the proper comparison is not with a fixed 5-year CD, but with a savings account. Laddering does better than that, and that’s the point behind it. Your points about inflation and all the hassle are valid, too. But, again, the comparison is with what you can get on other liquid investments. Laddering is, as you pointed out, work. As with everything, each… Read more »

Nick
Nick
5 years ago
Reply to  William

I understand your point about technique, I just think the numbers should be looked at a bit more closely. $1200 looks impressive reported by itself, but if you calculate the interest rate on that ladder ($1200 in interest over 5 years on a 20K means) it equals a 1.2% interest rate. This comes with the added expense of managing the ladder and locking up the liquidity of your assets into CDs. Considering current online savings accounts are earning 0.9-1%, ALL of the balance is liquid, and also takes no effort…I think it should be noted that CD ladders provide very… Read more »

William
William
5 years ago
Reply to  Nick

Yep… the key word there being “today.” The technique, I believe, is timeless, even though (as mentioned) in today’s climate its benefit may not be as great. Just good to have a reminder…

Jenny
Jenny
5 years ago

I do this for my “unemployment insurance” emergency savings (12 12-month CDs, each with enough to cover my basic expenses for at least a month). I have had to take some out for emergencies, but it’s mostly still there, although not earning me much at present. If I never need it for unemployment, my plan is to keep it around for retirement to help in riding out down markets. I have a separate $2000 in a savings account for things like unanticipated car repairs and vet bills.

Old Guy
Old Guy
5 years ago

Sorry to comment off topic, but GRS should post an article on Quantitative Easement. Your comment “these being the dog days of quantitative easing” brought the subject up, but no real discussion has been posted on GRS.

Abigail @ipickuppennies
Abigail @ipickuppennies
5 years ago

I looked into this, but with rates this low, it’s just not worth tying up our money.

If you don’t have a lot of funds to invest, it’s a lot riskier to have some of it inaccessible for any real period of time (without penalties, anyway).

Nick
Nick
5 years ago

Bingo!

K
K
5 years ago

We do a ladder for our mortgage payment emergency fund–a year’s worth of mortgage payments broken into 12 12-month CDs. We started building the funds by just setting up $100 CDs each month, then as each one matured we rolled it over and added funds to it until each CD was built up to a mortgage payment.

It was an easy and painless way to build up the emergency fund over time, have access to the funds regularly if needed, but still make a bit more than other savings options.

Beard Better
Beard Better
5 years ago

It’s good to have the knowledge about how to do laddering, but at this point in time I think the better question would be: why bother with CDs? With interest rates this low, you’re just losing money slightly less quickly to inflation by putting it in a CD than a savings or checking account, plus the loss of some liquidity. It doesn’t seem worth it unless you will need the money in under a year, but then there’s no point in laddering. It seems like the best option would be to put money you will need in the intermediate future,… Read more »

Chelsea @ Broke Girl Gets Rich
Chelsea @ Broke Girl Gets Rich
5 years ago

Interesting post and sound approach. I’ve only used a CD to invest money once, and was really impressed at how much more money was added to my total (for doing nothing!) when the time came to draw that money out. Of course, now I know a little more about personal finance and see that a better use for my money might have been to actually invest in something like a Roth IRA, but I think this is a good idea if you’ve got some shorter-term goals and you figure out that these CDs will give you the best rates in… Read more »

Chris @ThriveWP.com
Chris @ThriveWP.com
5 years ago

My wife and I have been talking about putting some of our savings into CDS. This article prooves I have a lot to learn. Thanks for the great read, we are going to need it!

Chris

Nick @ Millionaires Giving Money
Nick @ Millionaires Giving Money
5 years ago

Very interesting concept. This is the first time I’ve come across a laddered bond strategy and it seems quite effective. I have some money in a savings account earning pittances and this could be an effective way to bolster returns. Thanks for sharing.

Jason
Jason
5 years ago

I love articles like these. They give a unique twist on an old strategy for buying GICs. While I do not have $20k to invest, once I have my minimum cash stash saved I can then implement this idea. Who says you cannot make money with GICs/bonds? More ideas like this please!

Jason @addfinances
Jason @addfinances
5 years ago

I agree with you Abigail. If you do not have lots of savings, this might not be the best strategy to employ since it ties up your funds in a locked-in investment. Sometimes simpler is better, and a high interest savings account can work just as well or better than laddering. Still, I think this is an interesting concept.

Jason @addfinances
Jason @addfinances
5 years ago

Hi Jenny. I like your idea about using the laddering of GICs as an unemployment insurance savings fund. I can see a definite benefit from this strategy. For example, by having only $1000 per month available for withdrawal from the investment, you put a limit on the amount you can withdraw when you become unemployed. This helps prevent retail therapy sessions or spending more than you should when in this situation. Basically it provides a self-imposed boundary to prevent you from burning through your savings too fast.

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