How to Build the Best CD Ladder?

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Point of Interest

Building the best CD ladder starts with understanding the process, knowing the factors to assess, and learning what options are available for you to invest in.

If you’ve ever asked yourself, “What is a CD ladder?” we have you covered. CD ladders are a creative way of structuring your investments to provide extended liquidity, while still producing a high enough return to meet your financial goals.

In the simplest terms, a CD ladder is the process of buying multiple CDs spread out to mature over a period of time instead of one CD that matures at the end of the time period. The benefit? Flexibility, liquidity and, in some cases, better returns.

How does a CD ladder work?

If you were to purchase a five-year CD, you might get one of the best rates the financial institution has to offer. However, you won’t be able to touch your money for the full 60 months. With a CD ladder, though, you can build in some natural liquidity, and, in some cases, you may be able to earn a higher return.

For example, instead of buying that five-year CD, you might choose to buy five separate, smaller CDs — one each at one year, two years, three years, four years and five years. What this does is give you access to some of your money each year instead of just at the end of five years. After each CD matures, you can do whatever you want with the money. If you want to reinvest it in another CD, you could buy another 5-year CD to continue the ladder.

Additionally, you may be able to take advantage of better rates on shorter-term CDs. Sometimes banks run specials on shorter CDs that you can work into your ladder. You may be able to take advantage of these at the beginning of the process or if specials pop up when your CDs are maturing.

While CDs are a great, no-risk investment, you’re required to lock your money up for a longer period of time, which creates risk. However, by splitting up your longer-term CDs into a CD ladder, you eliminate a lot of this liquidity risk. Yes, most CDs will allow you to take out your money whenever you want, but you will incur a penalty.

6 steps to build the best CD ladder

1. Determine your financial goals.

Before you start building a CD ladder, determine what your financial goals are. How much money are you looking to have saved up? What is your reason for investing? What time frame are you planning to invest for? How liquid do you need your money to be? Are there particular times in the future you are more likely to need cash?

By answering these questions, you properly frame the CD ladder discussion. It can help you balance the returns you want and the need for liquidity.  

2. Determine how much you want to invest in CDs.

The next step is to figure out how much money you have to invest in your CD ladder. Are CDs your only investment, or are they rounding out an investment portfolio? Figure out the exact total dollar amount you want to be invested in all of your CD ladder legs combined.

3. Find the term lengths you want to use.

Generally, CD ladders are set up with a CD maturing every year, but it doesn’t have to be this way. You can set them up to mature every two years, every year starting in two years, at life-specific increments or really in any way that fits your needs. The most basic way, though, is one CD maturing every year on a five-year rolling basis. The advantages and disadvantages of each plan will depend on your financial goals and the rates being offered by banks and credit unions.

Additionally, you need to determine how much you want to allocate to each CD. The standard practice is to make each CD for the same amount. However, there may be some situations where you want to deviate from this. Some examples are when certain CD term lengths have much better rates or when you know you need access to a larger chunk of your funds at a particular date in the future. Again, the right answer here will be dependent on the financial goals you determined in step one.

4. Shop around for each CD term length you’re interested in.

From here, you need to start looking at the different rates that are available for the term lengths you’re looking to include in your ladder. Remember, a CD ladder doesn’t have to be built at the same institution — this is one of the biggest misconceptions with CD ladders. You can have different CDs at different banks or credit unions, depending on which offers the best rates and CD terms. While they are connected in your strategy, each product is still its own independent product.

5. Make your investments.

The next-to-last step of building the best CD ladder is making your investments. This is where you actually put your money in the various CDs.

6. Develop your plan for reinvestment.

The last step of the process is developing your reinvestment plan. While this can change as time goes on, it’s important to have a good idea of your ideal plan. Are you going to reinvest the money every time a CD matures? Are you going to use some of the CDs for particular expenses? Will there be other investments you want to investigate down the road? Will you have additional funds to add at later dates?

The final word

While CD laddering is not a magic elixir to earn higher profits, there are situations where you can manage better returns. In all situations, though, you can increase your liquidity, which lowers a lot of your financial risk. If you’re considering building a CD ladder, take the time to shop around for different options for each term length, and build the best combination available. It will take a little due diligence at the beginning, but the results and financial rewards could be well worth it.