Takeaways
- CD ladders are investment structures that stack CDs with different maturity dates.
- CD ladders give investors the flexibility to access their funds penalty-free.
- CD ladders provide fixed-income investors with sequenced interest income.
- Once a rung on a CD ladder matures, you can automatically reinvest the principal.
- Investors time CD maturities to align with their monthly cash flow and budgeting needs.
What Is a CD Ladder?
A CD ladder is a specific investment strategy that allocates investment capital among multiple certificates of deposit, or CDs, with lengthening maturities. This strategy helps investors manage risk associated with interest rate fluctuations, investment liquidity, monthly cash flow, and income payments.
By allocating funds across staggered CD terms, you can benefit from higher rates typically only offered for longer-term CDs while capturing short-term interest rates. You can also maintain access to your funds as each CD periodically matures or rolls off at a different point in time.
CD ladders are generally most useful for investors who need a slice of their portfolio exposed to savings accounts and interest rates and want to maintain a balance between interest yield and liquidity without the potential for high early withdrawal penalties.
In many cases, this makes CD ladders ideal for investors such as:
- Investors managing retirement funds
- Conservative investors who want passive income
- Savers who want a stable return or beginner investors
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How a CD Ladder Works
A CD ladder works by systematically staggering multiple CDs' terms and maturity dates, letting you invest and withdraw your money at relatively regular intervals.
How a CD Ladder Works
For example, if you have $10,000 to invest, you could divide it into five $2,000 CDs with terms of one year, two years, three years, four years, and five years. As each CD matures, you can reinvest the principal and the interest into a new CD with the same term, keeping your ladder intact.
Day one investment of 10,000:
- CD #1: $2,000, 4.5% APY, 1 year term
- CD #2: $2,000, 4.75% APY, 2-year term
- CD #3: $2,000, 5.00% APY, 3-year term
- CD #4: $2,000, 5.25% APY, 4-year term
- CD #5: $2,000, 5.50% APY, 5-year term
- CD #6 [When CD #1 Matures, Invest in another 1-year term]
As you can see, this solid strategy ensures portions of your investment become available at regular, consistent intervals. This gives you known liquidity time points and the opportunity to capitalize on fluctuating rates.
If inflation and interest rates rise, you can reinvest your money at higher rates as lower-rate CDs mature. On the other hand, if rates are falling, you can still benefit from the higher rates you locked in with your longer-term certificates. Balancing your approach lowers the risk you are exposed to while creating a steady and reliable income stream.
With falling interest rates, you can explore investing your excess funds in stocks, mutual funds, ETFs, real estate, commodities, or other investments to generate the investment returns you want.
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How to Build a CD Ladder
Building a CD ladder is relatively straightforward and involves a series of sequenced steps.
First, you need to determine the total amount you will invest in your CD ladder. Ideally, the amount you are willing to invest will be easily split into 5 or 10, the most common number of rungs on CD ladders. This will allow you to create a ladder with CDs of various terms.
Then, divide your total investment across the rungs equally. If you choose a 5-rung ladder to invest $10,000, you will want to invest $2,000 into each CD. Similarly, if you select a 10-rung ladder to invest $50,000, you should put $5,000 into each CD.
You can purchase CDs through your online stock brokerage account or at your online bank account. When buying CDs, always make sure you are staggering the maturity dates, such as six months, one year, two years, three years, and four years.
As each CD matures, reinvest the principal and interest into a new CD with the most extended unoccupied term in your ladder. Reinvesting maintains the ladder structure and lets you capture potentially higher long-term interest rates while getting regular access to your invested funds.
Be sure to monitor and review your investments regularly and adjust your CD ladder accordingly to keep it aligned with your long-term financial goals and market conditions.
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Advantages of a CD Ladder
Retail and institutional investors can harness the advantages of building a CD ladder. In fact, many companies use this investment strategy to capture yield on excess cash. Here are the biggest pros of a CD ladder:
- Access to Funds: Regular access to investment funds when each rung matures is incredibly attractive to investors who want a liquid portfolio.
- Staggered Income: Passive income investors can plan for staggered maturity dates, which allows them to follow a budget and map out their income streams.
- Automatic Roll: Some investment firms, like Fidelity, allow you to automatically reinvest your maturing principal into the next rung of the ladder. This can help if you are trying to automate your finances.[1]
- Higher Yields: CDs generally offer higher yields than checking, savings, or money market accounts because your savings are locked up until the CD's term. CD ladders are also considered a low-risk investment, primarily if investing in high-grade CDs.
- FDIC Insured: Many banks, investment firms, and credit unions offer CD ladders that are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000. Check with your CD ladder issuer to see if you invest in FDIC-insured investments.
Disadvantages of a CD Ladder
Even with attractive benefits, there are some possible drawbacks to CD ladders. Here are several to consider:
- Low Interest Rates: One big con of the CD ladder is that it generally yields lower rates of returns in low-interest rate environments than other riskier investments, like stocks, mutual funds, and ETFs.
- Potential Penalties: If you need access to your money before maturity, purchasing your CDs through a bank can result in early withdrawal penalties. However, if you purchase brokered CDs, there is no early withdrawal fee.
- Opportunity Costs: Lastly, CDs' fixed rates mean you might miss out on higher returns if rates spike during your deposit, which means you could have made more money in alternative investments.
5 Alternatives to a CD Ladder
Investors who gravitate toward investing in CDs are looking for high-interest income and a steady stream of cash. If you aren't sure a CD ladder is right for your financial situation, here are five other alternatives to consider:
- High-yield savings accounts offer incredibly competitive interest rates while providing easy access to your funds. The downside of these savings accounts is that the annual percentage yield (APY) varies based on the federal funds rate.
- Money market accounts can also provide similar benefits to CDS but grant the offerings of traditional checking account functions. With faster access to your cash and flexible account functionality, this could make more sense for your funds.
- Bond ladders are structured quite similarly to CD ladders. The difference, of course, is that bond ladders use various Bonds, such as corporate bonds, U.S. Treasury bills, and green bonds (particularly those interested in ESG investing), to construct their cascading maturities.
- Dividend Stocks give the stockholder the rights conferred to common stock, which entails the right to dividend distributions. Dividends are cash payments to shareholders and can generate passive income for investors.
- Real Estate Investment Trusts (REITs) are another source of income and capital appreciation. REITs pay their shareholders a distribution of rental income, and owners can also enjoy investment appreciation. Investors use REITs to expose their portfolios to real estate investments.
Read More: Explore more opportunities to invest and grow your capital by learning about the 7 asset classes
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Smart Summary
A CD ladder is an investment strategy that spreads investment capital across CDs of varying maturities and interest rates to provide investors with a consistent source of investment income. You can create a CD ladder on your own through your online brokerage account. Still unsure if a CD ladder makes sense for your portfolio. Consult a robo-advisor or financial advisor to see where a CD ladder fight fits your investment toolkit. If you like generating consistent passive income, a CD ladder could be exactly what you need to augment your portfolio.
Frequently Asked Questions
Building a CD ladder involves aligning your investment capital with your timeline for when you want to receive your interest payments. This investment strategy takes your investment deposit and evenly splits your funds across CDs, with each CD maturity creating a unique rung on your ladder. You can make a CD ladder for a couple of months to many years. Fixed-income investors deploy this investment strategy to help guarantee passive income.
You can withdraw funds from a CD ladder each time a CD matures. Otherwise, you might incur fees.
A CD’s annual percentage yield (APY) varies based on when you enter the ladder. APYs for each maturity vary based on market interest rates. Learn more about the Federal Reserve and how the federal funds rate affects interest rates.
Simply put, you get your principal plus your interest income. You can reinvest this money into another rung or invest it in another type of CD, stocks, bonds, or real estate. The choice is yours.
Once you set your CD latter structure, you can’t invest more, and the deposit, terms, and interest rates are set. After the “rungs” begin to mature and roll off, you can invest those excess funds back into extending the ladder.
(1) Fidelity. Model CD Ladders. Last Accessed January 14, 2025.
