Climb the CD Ladder for Safety and Flexibility

Here’s how spreading your money across multiple CDs may provide more income and easier access to your money compared to investing in a single CD.

Close Up of Hand Reviewing Financial Information

by NEA Member Benefits

Key takeaways

  • Many financial institutions will automatically roll over your CD into a new certificate when it matures. This can make CD ladder management easier over time.
  • Money earned on CDs is considered interest income and is taxed in the year you receive the interest. The taxes you pay effectively reduces the interest you earn, so always factor in taxes when calculating your true investment returns.
  • If you withdraw money from a CD before the maturity date, you will typically pay a penalty and/or forfeit some of the interest you would have earned.

What’s a CD?

Certificates of deposit, CDs for short, have long been a popular investment choice of conservative investors. CDs are basically a promise by a bank to pay you a specified rate of interest in return for your investment of a fixed amount for a fixed period of time.

For example, a bank may offer a CD with a one-year maturity term that pays 2.5% interest if you invest a minimum of $5,000. In this case, you give the bank $5,000 with the promise that you won’t withdraw your money, and one-year later, when the CD matures, you get your $5,000 back plus $126.44 in interest.1

The interest rate (technically called the CD’s annual percentage yield) varies based on the maturity of the CD, with longer maturities paying higher yields. Minimum deposit amounts can also figure in to the yield offered. Generally, the more you invest, the higher your potential yield, comparatively speaking. For example, a one-year CD with a $5,000 minimum deposit may pay 2.5%, while a five-year CD with a $2,000 minimum deposit may pay 3.3%. In general, you get paid more the longer you agree to tie up your money. 

CD advantages

One big advantage CDs offer is safety. Because CDs are sold through banks, your money is insured against loss by the Federal Deposit Insurance Corporation (FDIC) up to $250,000, just as it would be in a bank savings or checking account. The other advantage is you know going in what your money will be earning over a certain period of time and when you’ll receive those fully taxable earnings. This makes it easier to plan your investment income for cash flow and tax purposes.

Spreading risk with a CD ladder

One popular strategy for increasing the yields on CDs without locking up all of your money for many years is CD laddering. With CD laddering, you divide the total amount of money you want to invest into equal amounts and put it in several CDs with different maturity dates.

Let’s say you have $5,000 to invest. You could put $1,000 each into five CDs with maturities of five, four, three, two and one year. As each CD matures, you bank the interest and reinvest the original $1,000 into another CD to keep the ladder intact. You’ll receive steady cash flow from interest payments as shorter-term CDs mature and your average annual yield may be higher because some of your money is in longer-term CDs, which pay a higher yield. Plus, only a portion of your money will be tied up for five years, leaving you free to use the cash as shorter term CDs mature, if necessary. A CD ladder also gives you flexibility to reinvest maturing money into higher yielding CDs if interest rates start to rise.

CD Ladders may lead to higher interest income

Back in 2014, the financial publishing website projected how three different risk-free CD investing strategies compared over a five-year period starting in 2009. At the time, interest rates were much lower than they are today, but the results are still worth considering.

  • Strategy 1: Invested $10,000 in a bank money market account. Result in 2014: $77 in interest income.
  • Strategy 2: Invested $10,000 in one-year CDs and reinvested each year. Result in 2014: $241.14 in interest income.
  • Strategy 3: Invested $10,000 in a five-year CD ladder, reinvesting each CD in the longest term CD as each matured. Result in 2014: $729 in interest income.

The CD ladder was clearly the more effective strategy in this example. Of course, there is no guarantee that these results can be duplicated in different interest rate environments, but it shows the potential value of CD ladders compared to putting everything into single account. And remember, each of the strategies offered the same FDIC-insured safety net.

Protection against rising interest rates

As of mid-2018, interest rates continue to rise, along with inflation. A shorter-term CD ladder may protect you from rising rates because as each CD in your ladder matures, you’ll have the option of reinvesting into a higher rate CD.

“Investing in 1-year, 2-year, 3-year and 4-year CDs might make sense in a normal interest rate environment. But if rates and inflation are picking up, you should consider building a ladder that includes CDs with shorter terms,” says John Piershale, a wealth advisor at Piershale Financial Group in Crystal Lake, Illinois.2

1 Interest rates mentioned in this article are for general comparison purposes only and are based on select rates reported by as of August, 2018. CD yields change regularly so your yields may be higher or lower.

2 Cited from on August 9, 2018.