Manage Your Cash with a CD Ladder

How to Setup a CD Ladder

cd ladderWith CD rates being so low, you may not think that investing in certificates of deposits are a good idea.  However, if you want 100% guaranteed security on your principle, using a certificate of deposit can be a smart move.  However, you don’t want to be locked in to low CD rates when CD rates could rise in the future.  As such, setting a up CD ladder can make a lot of sense.

How Certificates of Deposit Work

Certificates of Deposit are a special kind of deposit account offered by banks and they are FDIC insured.  This means that the federal government insures your money.

A CD offers a variety of different terms and rates.  Typically, you get lower rates for shorter terms, and higher rates for longer terms.  However, in exchange for the rate you receive on your money, your money is tied up for the set term.  If you withdraw your money early, you typically forfeit the interest you earned, or pay some percentage of it as a penalty.

The typical terms are anywhere from 90 days, 6 months, 1 year, all the way to 5 years.  Each bank has different minimums, but most CDs must be at least $100 investments.  Some banks offer higher interest rates if you deposit larger balances, like $10,000 or more.

Setting up a Ladder

Now that you understand the basics of a CD, you will know why laddering is a great idea.  Let’s say you have $10,000 to invest, but you’re leery about the low interest rates.  You know they’ll rise in a few years, so you don’t want to lock up all your money at low rates.  That is where laddering comes in.

In CD laddering, you invest a portion of your total balance in different maturity CDs.  This gives you the benefit of higher returns on the longer terms, but gives you the ability to get your cash out sooner on the shorter returns.

Check out this scenario with your $10,000:

  • $2,000 in 1 year CD at 0.50%
  • $2,000 in 2 year CD at 1.00%
  • $2,000 in 3 year CD at 1.50%
  • $2,000 in 4 year CD at 2.00%
  • $2,000 in 5 year CD at 2.50%

After 1 year has elapsed, you will get $2,000 back (plus interest) that you can reinvest.  If rates have gone up, you can re-invest in a 5 year CD to get the highest rate now, say 3.00%.  The ladder continues, since the original 2-year CD now only has 1 year left.  You can continue doing this over time to keep your money safe while taking advantage of higher interest rates.

Readers: Have you ever invested in CDs? Would you consider using a CD Ladder to take advantage of higher interest rates?

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4 Responses to Manage Your Cash with a CD Ladder

  1. Jackie 11/24/2012 at 10:06 pm #

    I like CD ladders for an emergency fund. Since an emergency fund’s primary use is to be available when you need it, and typically all you lose if you withdraw from a CD early is 3 months’ interest, they seem like a win-win to me.

    • Paul 11/25/2012 at 12:33 am #

      If you are keeping a substantial sum of cash on hand, a CD ladder can be a useful tool to increase your return while ensuring you have cash available when needed.

  2. John@MoneyPrinciple 11/20/2012 at 9:27 pm #

    Seems a good idea. I will add it to our investment plans!

    Although interest rates are so low at the moment so I don’t think we will be dropping the odd ten grand into anything!

  3. Untemplater 11/20/2012 at 5:44 am #

    I invest in CDs a lot but never thought about laddering. Makes sense! I probably wouldn’t ladder more than 2 or 3 different maturities at once, but good to know there’s the option to.

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