What is a CD Ladder?

By Stew

I have invested in Certificates of Deposit or CD’s a number of times over the past two decades and lately, I have been doing some reading on the concept of a “CD Ladder”.

I first heard the term CD Ladder several years ago while listening to a Saturday morning radio show that dealt with topics like mutual funds, annuities and estate planning.

Most of you are familiar with a Certificate of Deposit. CD’s are investment vehicles, generally offered by banks where an amount of money is invested for a set period of time at a set rate of return. There is a fair amount of variation on CD terms, however the basics stay the same: a guaranteed rate of return for a set period of time and the investor cannot access the money until the CD matures. Banks often offer better rates of return on CD’s because they know exactly how long they will be in possession of the money, while savings account interest rates are lower because the investor can take the money out of the bank at any time. One good source of current CD rates can be found at Bank Rate.

CD’s have two major advantages: your money is safe, FDIC insured, you are protected against losing your investment and the higher-than-savings-account guaranteed rate of return. CD rates vary according to the length of time specified in the CD terms – the longer the term, the higher the rate. The point is that the length of time and the rate of return are locked in, they cannot change and they provide the structure for the concept of a CD Ladder.

A CD Ladder is set up when a person purchases a large number of smaller CD’s rather than placing all of their working capital in a single CD. Here is a possible scenario using a balance of $10,000:

  • CD #1 $2000 for six months at .75%
  • CD #2 $2000 for 12 months at 1.10%
  • CD #3 $2000 for 18 months at 1.37%
  • CD #4 $2000 for 24 months at 1.69%
  • CD #5 $2000 for 30 months at 2.01%

I’m totally pulling numbers out of the air here, but the concept is that you will be able to receive income at regular intervals, while still earning the highest rate possible with the rest of your capital. Obviously, you can adjust the amounts and intervals to fit your situation. In these days characterized by stock market volatility and a lack of job security CD’s might be the best way to earn passive income with as little risk as possible.

Individuals with the following characteristics are the most likely to benefit from a CD Ladder:

  • Individuals nearing retirement who do not need stock market returns and who cannot risk losing capital.
  • Individuals with large amounts of liquid capital.
  • Individuals who do not need a lot of money to live (i.e. low debt, low expenses, no dependents, etc.)

The most important thing to remember about CD’s is that while they are low risk, you will not be able to touch that cash for a period of time. This means only open a CD with money that you can live without for some time. CD’s do offer early withdrawal, but usually there is a significant penalty and the chance that you will not collect any interest.

Article by Stew

Photo by Robert S. Donovan

5 Responses (including trackbacks) to “What is a CD Ladder?”

  1. Randy Says:

    Using your CD ladder, when CD#1 matures, would you then reinvest for 30 months? And the same for the other CD’s?

    Given the low rates today, I don’t find a lot of interest in CD ladders. Many banks offer a “raise your rate” CD, where they allow you to increase the rate once (or more) during the term of the CD.

    Also, the penalty for early withdrawal is often (always?) only the loss of interest. In your example, the 30 month CD is only 2.01% That’s only about $100 at the end of the term. So the worst penalty (if you withdrew on month 29) would be about $100. Not much of a penalty if you ask me.

  2. Carol@inthetrenches Says:

    My question is basically the same as Randy’s. With such low interest rates is it worth tying up the money?

  3. Deb Says:

    I used to ladder CDs, but haven’t for a while now because of low interest rates. You’d be better parking your money in a Money Market account IMO. I like ING. I stick with them because I don’t like chasing rates.

    The last time I invested in CDs was with WAMU, just prior to their acquisition by Chase. They offered 7-9 month CDs at 4.25% interest rate. It was short term enough that I felt comfortable putting some cash in, and the interest was worth it. Otherwise, I wouldn’t bother for now.

  4. Stew Says:

    The rates are low . . . however, if you have a large amount of capital that you do not want to risk, a CD makes sense. Money Market accounts sometimes have better APR’s than savings accounts, but rarely do they go as high as a CD. Furthermore, MM interest rates can fluctuate . . .

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