A certificate of deposit (CD) ladder is a savings instrument for investing your lump sum of cash across various certificates with different maturities. You will earn a fixed interest rate over some time, allowing you to maximize your earnings on money lying in your bank account. 

Once you complete the maturity, you can take the capital and reinvest it in another CD. While building the ladder, your CDs will mature in rotation. Read the article to know how to build a CD ladder, and its advantages and disadvantages. 

Steps to Build a CD Ladder

You will need a plan before you start working on the ladder. The best part is that you can begin with as little as $100. However, decide the amount based on your income and how frequently you require penalty-free cash. 

Since the CD ladder has multiple rungs, you can build the CD ladder of any height. For example, two CDs will give a short ladder and 10 CDs, a taller one. An ideal CD ladder should balance money and investment goals. 

Let’s say you want to invest $2000 and want a multi-year-ladder, here are key steps you need: 

Step 1: Open Different CDs

Maturity dates range from three months to 5 years or more. Instead of putting the entire amount in a 4-year CD, divide the amount equally into 4 types: 

$500 in a 1-year CD

$500 in a 2-year CD

$500 in a 3-year CD

$500 in a 4-year CD

Alternatively, you can go for a 3-month interval plan (3, 6, 9 and 12 months) depending on your need for cash. 

Make sure you do sufficient research on CDs with the highest interest rates possible to maximize your earnings. Also, you can purchase CDs from different banks, instead of putting all your eggs in one basket. 

Compare CD terms, like opening deposit requirements, fees early withdrawal penalties, etc. Check if the CD issuer is insured through the Federal Deposit Insurance Corporation (FDIC). If you go via credit unions, they should have the National Credit Union Administration (NCUA) insurance. 

Step 2: Reinvest CDs or Cash Out? 

As your CD matures, you have two options – either reinvest the amount or cash out. If you reinvest, the ideal thing is to buy the next CD with the longest term, giving the highest interest rate. This way, you will have four new CDs maturing at your preferred intervals. 

When the first CD matures, you can take the $500 and get another 3-year CD. Do the same with the other three maturities. At some point, your CDs will mature at various intervals, all earning interest. 

Please note: in a volatile environment, your interest rates might fluctuate. Always keep an eye on your bank or credit union to see what they are offering. 

Benefits to CD ladders

Typically, CDs have higher interest rates compared to most traditional savings accounts. 

It is a safe investment instrument since the issuer is insured. FDIC insurance protects against losing up to $250,000. 

It offers a steady income stream with minimal risk. 

Rolling over your CDs on schedule will give you higher interest rates while reducing interest rate risk. For instance, you can take advantage of the rising short-term interest rates in your first round of investment. The matured amount can be invested into a new CD with a higher interest rate. In case, if the interest rates fall, you can still get the benefits of the stable and higher rates of long-term CDs. 

There are very minimal or no monthly fees.

A CD ladder approach ensures a steady cash flow. 

Cons of CD ladders

There is an inflation risk associated with CDs. Sometimes, you might get a negative return.

You might not have constant access to all your funds. You may have to pay a penalty if you cash in before the maturity period. 

You will have to remember and monitor your maturing date as the bank will give a short-term window (7-10 days) before automatically renewing CDs for a similar term. 

CD ladders do not always give you tax benefits. The earnings from CDs are taxable, but their principal sum is not. 

Alternatives to a CD Ladder

Barbell CD Ladder: This strategy is a combination of short-term and long-term CDs, where one part of your investments provides liquidity and the other part offers potentially higher returns.

Bump-up CD Ladder: This strategy offers a one-time interest rate increase when the bank raises its CD rates. 

Bullet CD Ladder: In this approach, you invest in various CDs, but all maturing on the same date. This is ideal for those having a specific goal such as buying a car, a house or taking a trip 

Deciding if a CD ladder is suitable for you depends on your financial objectives. Generally, CD ladders are ideal for those seeking a safer investment option with predictable cash flows.