What Is a CD Ladder and How to Build One What Is a CD Ladder and How to Build One
A Certificate of Deposit (CD) account is an interest-bearing account opened for a specific period of time that earns a fixed income on the amount initially deposited. A CD ladder strategy is an approach that involves opening multiple CD accounts with different maturity dates allowing investors to take advantage of higher interest rates while keeping a portion of their funds liquid at all times.
Below we'll dive into greater detail as to how a CD ladder works, how to build a CD ladder, the advantages and disadvantages of this strategy, and some other frequently asked questions about CD ladders.
What is a CD Ladder Strategy?
As mentioned above, a CD ladder involves spreading a sum of your savings across multiple CDs with different term lengths. By opening a mix of longer-term CDs and shorter-term CDs, you'll be able to enjoy the higher rates of long-term CDs while maintaining liquidity through shorter-term CDs. When one of the shorter-term CDs in your ladder matures, you can decide whether to renew the account, reinvest the money into another CD account, or use the money for more immediate needs while the money in your long-term CDs continues to appreciate in value.
One of the main drawbacks of a single CD is the tradeoff between locking your money into an account for a longer period of time in order to obtain a higher rate of return for your funds. A traditional CD ladder provides a solution to this conundrum by allowing investors to take advantage of a fixed interest rate while maintaining some liquidity with their funds. Also, a CD ladder offers a solution to having to time a CD investment strategy perfectly against when rates rise or fall because it allows investors to remain nimble with some of their funds.
How Does a CD Ladder Model Work?
Let's suppose you have $5,000 to invest and you decide to pursue a CD ladder to get the most out of your hard-earned savings while maintaining some liquidity with your funds. Below is an example of how you might create a five-year ladder with CDs maturing at different intervals.
- $1,000 in one-year CD
- $1,000 in a two-year CD
- $1,000 in a three-year CD
- $1,000 in a four-year CD
- $1,000 in a five-year CD
After the one-year CD matures, you reinvest the $1,000 (plus interest) in a new 5-year CD, and so on for each subsequent year as each CD matures. This means that every year you'll have a CD term maturing and the funds available for reinvestment while still benefitting from the higher interest rates of CDs with longer terms. Plus, by spreading out your investments, you minimize the risk of locking in your money at a low rate for too long.
Keep in mind, one of the main advantages of a CD ladder is flexibility of your funds. If one of the CD accounts in your ladder matures and you need all or a portion of those funds for something else (buying a house, buying a car, or paying for educational expenses), or if you decide CD rates have gotten too low and you can get a better return investing your money elsewhere, you may decide not to put your money back into your CD ladder.
What is a Mini CD Ladder?
A mini CD ladder involves a similar approach as a regular CD ladder, but with short-term CDs. For instance, a mini CD ladder could be comprised of a three-month CD, six-month CD, nine-month CD, and 12-month CD. One of the advantages of short-term CD ladders is even more flexibility for your funds because your accounts will be maturing every few months. A drawback is that interest rates might be lower than with a long-term CD ladder.
What Are the Advantages of CD Ladders (And Disadvantages)?
Pros of CD Ladders:
- Liquidity: Because ladders are comprised of CDs with different terms, you'll have a portion of your original investment available to you at regular intervals when the CD with the nearest maturity date arrives.
- Flexibility: When one of the CDs in your ladder reaches maturity, you can either reinvest the funds to continue the ladder, invest them in another method for a better rate (like a high-yield savings account, money market account, or retirement account), or use them as needed based on your investing strategy.
- More Competitive Interest Rates: By opening a number of CDs with varying terms, you'll benefit from the high rates associated with a longer-term CD.
- Protection From Fluctuating Rates: Once you open your CDs you don't need to worry about interest rates declining. When you start a CD ladder, you'll lock in your rates for the duration of the term of each account. And if rates rise, you'll be able to lock in an even better rate when an account reaches maturity by continuing your ladder.
Cons of CD Ladders:
- Early Withdrawal Penalties: Even though you will maintain a certain amount of liquidity with a CD ladder, you'll still need to be aware of the early withdrawal penalties associated with Certificate of Deposits. In most cases, your financial institution will assess you for an early-withdrawal penalty or fee on the interest you've gained before you get your money back if you decide to withdraw it from your account before it matures.
- Requires Active Management: Most CDs have a short window of time around the maturity date where you can withdraw funds or roll them into another account without incurring a penalty. If you fail to take action during this window, your funds could just roll into an account with the same term, thus disrupting your ladder strategy.
- Works Best with a Lump Sum: A CD ladder is a great strategy if you have an existing chunk of savings you're looking to grow, but if you're just starting to grow your savings you may want to explore a high-yield savings account instead.
How to Open a CD Ladder
Opening a Certificate of Deposit with Leader Bank takes only a few minutes and can be done online from anywhere! Leader Bank also offers a range of flexible short and long-term CDs that are perfect for building your ladder.
