How To Put CD Laddering to Work for You

Accumulating money in your savings account feels good until you realize it’s just sitting there earning almost no interest. Putting it in CDs could be the answer, except, you may need those funds to pay an unexpected medical bill or replace your furnace. CD laddering can give you both the stability of a guaranteed investment and the flexibility of quick cash when you need it.

What is a CD? 

A certificate of deposit is an FDIC insured investment product available through most financial institutions including Isabella Bank and commonly just referred to as a CD.

The term and interest rate of the investment are set by the financial institution, based in part on current interest rates. The interest rate offered by the financial institution is good for the duration of the investment.

Most CDs range in duration from three months to five years. Financial institutions typically offer a higher interest rate for the longer terms. For example, a financial institution may advertise 0.65% for three months, 1.25% for six months, and 1.80% for one year. Some CDs, but not all, require a minimum investment of $500, $1,000, or more.

You choose how much money you’d like to put into a CD and agree to the terms offered. The financial institution will send you regular statements to help you keep track of your money, just like a savings account. CDs earn compound interest, which means the interest you earn is added to the balance so it can also earn interest.

CD Pros and Cons

A CD is a good option if you are concerned about volatility in the stock market. Your investment will be safe; the rate of return on a CD is guaranteed. CDs are also insured by the federal government up to $250,000 per depositor, so even if the financial institution goes out of business, your money is safe. You won’t get a very high rate of return on a CD like you might on a stock, but the interest rate is guaranteed. Plus, investing in a CD will give you a higher rate of return than keeping your money in a typical savings account.

Compared to other investment products like stocks or mutual funds, a CD is a short-term commitment. Still, you are not able to withdraw your money from a CD as easily as you could from your savings account. If you had your emergency fund invested in a CD and your furnace quit, for example, you would have to decide whether to wait for your CD to mature or pay the penalty for early withdrawal. Some emergency expenses can’t wait six months to a year or more for a CD to mature.

The CD Ladder Method

Because you would pay a penalty to withdraw money invested in a CD earlier than its maturity date, it might not be advantageous to invest all your available funds in one CD and hope you don’t need that money until the CD matures. CD laddering, however, eases this problem.

With CD laddering, you would divide up the money in your savings account and buy separate CDs with different dates of maturity. This way, instead of waiting five years for one CD to mature, you could have a CD maturing every few months or each year. When each CD matures, you can decide if you want to buy another CD at the same or longer term, use the money for something else, or a little of both. A CD ladder gives you access to some of your money every year while you are earning a higher rate of interest than you would by keeping the money in a savings account.

How to Build Your CD Ladder

To get your ladder off the ground, decide if you want to work with a long-term CD laddering approach or a short-term laddering approach. In a short-term laddering approach, divide your money into four equal parts. Invest each part in a different CD: one that matures in three months, one that matures in six months, one that matures in nine months, and one that matures in 12 months. After each matures, you can decide how much of that amount you want to reinvest in a one-year CD. This method gives you access to your money without penalty every three months. 

To build a long-term CD ladder, divide your funds into five equal parts. Put each part in a different CD: one that matures in one year, one that matures in two years, and so on. Now you have five CDs, one maturing every year for the next five years.

Every time one of your CDs matures, you can decide what you want to do with that money. You may have an emergency expense you need to spend it on. If not, you may choose to reinvest it. Buying another five-year CD will add to your ladder. If you buy a new five-year CD every year, your ladder will continue.

For example, if you have $2,500 in your savings account, you could invest it in a long-term CD ladder like this:

• $500 in a CD at 1.0% for one year
• $500 in a CD at 1.5% for two years
• $500 in a CD at 2.0% for three years
• $500 in a CD at 2.5% for four years
• $500 in a CD at 3.0% for five years

With this investment plan, you will have a CD maturing each year for the next five years. Let’s say you started your CD ladder in 2022. That would mean your first CD matured in 2023. By adding another five-year CD when that one matured, your ladder would reach into 2028. 

For the first four years, your CD ladder would earn a lower interest rate. But once you reach the fifth year, and every year after that that you add another five-year CD, you would earn the premium rate offered for the longer-term investment. As interest rates rise, each successive CD you buy into will earn a higher yield. 

When each CD matures, you can reinvest the initial $500 plus the interest you’ve earned over the term of the investment. Each year, you will be increasing your principal investment, like this:

• $500 + one year of interest reinvested for five years at 3.0%
• $500 + two years of interest reinvested for five years at 3.0%
• $500 + three years of interest reinvested for five years at 3.0%
• $500 + four years of interest reinvested for five years at 3.0%
• $500 + five years of interest reinvested for five years at 3.0%

After five years, each of your CDs would be adding five years’ worth of interest, and you would be reinvesting that money at the premium rate. Your CD ladder may start slow, but in just five years you could reach your full CD investment potential. By laddering your CDs, you build in the flexibility of having access to liquid assets each year if you need them.

Contact Us

If you have questions about CD laddering or any savings or investment products, contact us. We are here to help you make the most of your money.

Rates in this article are examples and do not reflect Isabella Bank’s current CD rates. For current CD rates please contact us.