What is a CD Ladder?
A CD ladder is a group of CDs organized to mature over time. Imagine a ladder with 10 steps, and each step is farther away from the ground. With a CD ladder, you have a series of CDs maturing further and further out in time.
You might take $400 to the bank and build a CD ladder with the following 'rungs':
- 1 year CD - $100
- 2 year CD - $100
- 3 year CD - $100
- 4 year CD - $100
Why Use CD Ladders?
People use CD ladders for flexibility and simplicity. They make CD investing easy, and they reduce the likelihood that you’ll make a bad decision. To see the details on why CD ladders are popular, see Why Use CD Ladders?
CD Ladder Length
How long should your CD ladder go? It depends on what you’re trying to accomplish. Most people stop at 3 to 5 years. CDs with long maturities pay higher rates, so a longer CD ladder should earn you a little bit more. However, you have to be comfortable with locking the money up.
How Far Apart?
You also have to decide how far apart each rung should be. Should you use 3 month CDs or 2 year CDs? Most people settle on 6 month or 1 year maturities within a CD ladder. If you go any shorter, the CD ladder becomes high maintenance. However, you can get creative with CD ladders to accomplish any goal you have.
When CD Ladders are Bad
CD ladders are a great way to invest in CDs. However, you should avoid them if you can’t stick with the program over the long term. If you think you’ll have to break down the ladder, any early-withdrawal penalties might more than wipe out the extra interest you earn. Just use a savings account instead.
You should also avoid CD ladders (or keep them short) if you know that interest rates will rise in the future. The point of using CD ladders is to avoid thinking about these things, but there may come a time when you can reasonably predict what CD interest rates will do.Alternatives to CD Ladders
If you decide not to use a CD ladder, where else can you put cash? Savings accounts are a good alternative. Online banks may pay as much as some CDs. You should also look into ‘rewards’ or interest checking accounts, which pay high interest on liquid cash.
The problem with these alternatives is that you don’t get a guaranteed rate. Interest rates will fluctuate, and if they head down then you might have been better off in a CD.