Reduce Risk with a CD Ladder

  • 5 minute read

If you’ve been thinking about putting some money away in a safe and secure investment, but you’re not quite sure where to start, this is the article for you. Maybe you’ve heard whispers about certificates of deposit (CDs) being a good option, but what’s the deal with CD ladders? Here, we’ll teach you how to build a CD ladder.

In this post, we’ll explore CD ladders and how they can be an effective investment strategy for those who are more risk-averse. We’ll discuss the basics of CDs, how to build a CD ladder, and why this approach might be the ideal investment strategy for you.

Certificates of Deposit: A Quick Primer

Before diving into CD ladders, let’s briefly go over what CDs are and how they work. A certificate of deposit is a type of time deposit offered by banks and credit unions to customers who are looking for a low-risk investment option.

When you open a CD, you agree to deposit a specific amount of money in the account for a predetermined period, known as the term. The term can range from a few months to several years, depending on the specific CD product. In exchange for locking away your funds for the agreed-upon term, the bank pays you interest, usually at a higher rate than you’d get with a regular savings account or money market account.

CDs offer several advantages, such as predictable interest income, low risk, and protection by the FDIC or NCUA, up to applicable limits. 

However, CDs also come with some drawbacks. The most notable is the penalty you’ll likely face if you need to withdraw your money before the end of the term, which can vary depending on the bank and the specific CD product. Additionally, CDs typically offer lower returns than other types of investments, such as stocks or bonds.

The CD Ladder Strategy

Now that we’ve covered the basics of CDs, let’s delve into the concept of CD ladders. A CD ladder is an investment strategy where you spread your money across multiple CDs with different maturity dates. This approach provides a balance between earning interest and maintaining liquidity, making it an attractive option for conservative investors.

how to build a cd ladder

By creating a CD ladder, you ensure that a portion of your money becomes available at regular intervals, allowing you to reinvest in new CDs with the longest term in your ladder or access the funds as needed for other financial goals. Here are some key benefits of the CD ladder strategy:

  • Higher returns – Longer-term CDs typically offer higher interest rates than shorter-term CDs or traditional savings accounts. By including longer-term CDs in your ladder, you can earn higher returns on a portion of your investment.
  • Regular access to funds – With a CD ladder, you’ll have CDs maturing at staggered intervals, providing you with regular access to a portion of your funds. This can be helpful if you anticipate needing access to your money for planned expenses, emergencies, or other financial goals.
  • Flexibility to adjust your strategy – As each CD matures, you can decide whether to reinvest the funds in a new CD or use them for other purposes. This flexibility allows you to adapt your CD ladder strategy based on your changing financial needs and the prevailing interest rate environment.
  • Reduced interest rate risk – If interest rates rise, you’ll have the opportunity to reinvest your maturing CDs at higher rates. Conversely, if interest rates fall, only a portion of your CD ladder will be affected, as your longer-term CDs will still earn interest at the previously locked-in rates.

By understanding the CD ladder strategy and how it can help you achieve a balance between earning interest and maintaining liquidity, you can make informed decisions about whether a CD ladder is the right investment approach for your financial goals.

Building a CD Ladder: A Step-by-Step Guide

Ready to construct your own CD ladder? Let’s walk through the process step by step:

1. Determine your investment amount

Before you begin, decide how much money you want to invest in your CD ladder. This will help you figure out how much to allocate to each CD. Consider your financial goals, risk tolerance, and any upcoming expenses when deciding on the total investment amount. 

Remember that you can always start small and expand your CD ladder as your financial situation allows.

2. Choose your CD terms

Next, you’ll need to select the terms for your CDs. To create a ladder, you’ll want to spread your investment across CDs with varying terms. This approach helps ensure that your money is not locked up for an extended period and provides a balance between liquidity and return. 

Let’s say you have $15,000 to invest, and you want to create a CD ladder to balance between earning interest and maintaining liquidity. You could set up the following CD ladder:

  • 6-month CD – Invest $3,000
  • 1-year CD – Invest $3,000
  • 2-year CD – Invest $3,000
  • 3-year CD – Invest $3,000
  • 5-year CD – Invest $3,000

In this example, you have evenly distributed your investment across five CDs with varying terms, from 6 months to 5 years. As each CD matures, you can decide whether to reinvest the funds in a new CD with the longest term (in this case, a 5-year CD) or use the money for other purposes, depending on your financial needs at the time.

With this CD ladder, you’ll have a portion of your investment maturing every 6 months to 1 year, providing you with regular access to your funds. At the same time, you’re taking advantage of the higher interest rates typically offered by longer-term CDs.

This is just one example of how you can structure a CD ladder. Depending on your specific financial goals and risk tolerance, you may choose to create a ladder with more or fewer rungs or with different term lengths to suit your unique needs.

3. Divide your investment

Now it’s time to distribute your investment among the chosen CDs. To do this, divide your total investment amount by the number of CDs you’ve chosen. For example, if you want to invest $10,000 in a 5-tiered ladder, you’d allocate $2,000 to each CD.

4. Open your CDs

With your investment plan in place, it’s time to open your CDs. It’s essential to shop around for the best interest rates, as they can vary between banks and credit unions. Consider factors such as minimum deposit requirements, early withdrawal penalties, and the financial institution’s reputation when comparing your options.

To make the most of your CD ladder, keep these tips in mind when opening your CDs:

  • Compare rates online – Use online resources and comparison tools to research and compare the interest rates offered by different banks and credit unions.
  • Check for promotional rates – Financial institutions sometimes offer promotional rates on CDs for new customers or for a limited time. Keep an eye out for these deals to potentially lock in a higher rate.

  • Consider online banks – Online banks often offer higher interest rates on CDs than traditional brick-and-mortar banks due to their lower overhead costs. Don’t overlook these options when shopping for CDs.

Once you’ve identified the best rates and terms for your CDs, go ahead and open your CDs with the chosen terms and investment amounts. Make sure to keep track of the maturity dates and any renewal options or deadlines, as this information will be crucial for maintaining your CD ladder in the long run.

5. Maintain the ladder

As each CD matures, you have the option to reinvest the funds in a new CD with the longest term in your ladder. For example, when your 1-year CD matures, you could reinvest the funds in a new 5-year CD. This process helps you maintain the ladder structure while taking advantage of potentially higher interest rates.

Weighing Costs and Benefits

CD ladders can be an attractive investment strategy for those who prioritize safety and want to earn higher interest rates than traditional savings accounts. By spreading your money across multiple CDs with varying terms, you’ll maintain some liquidity while still taking advantage of the benefits CDs have to offer.

However, it’s essential to consider your individual financial goals and needs when deciding if a CD ladder is right for you. If you need quick access to your funds or prefer investments with the potential for higher returns, a CD ladder might not be the best fit. On the other hand, if you’re looking for a low-risk option to diversify your investment portfolio and are comfortable with the trade-off between liquidity and return, a CD ladder could be an excellent choice.

In any case, it’s always wise to consult with a financial advisor to discuss your specific situation and determine the best investment strategy to help you reach your financial goals. With careful planning and the right investment approach, you’ll be well on your way to a more secure financial future.