CD Ladders and Your Savings

By April Dykman

High-interest savings accounts are a good way to safely grow your money, whether you're saving for an emergency fund, a dream vacation, home renovations, or some other goal. But even the highest-yield interest accounts can sometimes disappoint when annual percentage yields (APYs) drop across the board.

Think CDs to Supplement Savings Accounts

When rates are low and you don't want to stash your short-term cash in riskier investment options, certificates of deposit (CDs) are a good place to ensure a return on your investment. A CD is a deposit account much like a money market or savings account. You earn interest on your deposit, and if your bank is FDIC-insured, your cash is protected up to the allowable limit.

The difference between a CD and regular savings account is that when you open a CD, you invest a set amount of money in the account for the required time, after which you keep the principal plus interest. If you have to liquidate the CD (take money out) before the term is up, the bank can keep some or all of the interest that accrued, possibly with penalties.

Boost Savings Account Rates with a CD Ladder

If you're worried about tying up your entire savings in a CD for a long period of time but you want better returns, you can structure your CDs into a CD ladder. To create a CD ladder, you buy CDs with staggered maturity dates. Every so often--say, once every six months--one of your CDs matures, freeing up some cash for any short-term needs. If you don't actually need to withdraw your funds then, you can let it roll over into another CD term.

Setting Up the Ladder

Creating a CD ladder is pretty simple. Here are the steps:

  1. Decide on a bank. Some banks have a minimum amount you have to invest to open a CD, and others let you invest any amount. Also compare CD rates to find the highest return. Sometimes brick-and-mortar banks offer better rates than online banks--so shop online for the highest rates but don't overlook your local bank.
  2. Figure out how many "rungs" you need on your ladder. If you're nervous to have your money tied up for too long, try a ladder with shorter terms to maturity, such as 6-, 12-, 18-, 24-, and 30-month CDs. If you can afford to be more aggressive and put in money for longer periods, however, you'll get better rates. A more aggressive ladder might be 12-, 24-, 36-, 48-, and 60-month CDs.
  3. Open each CD in your ladder. Each CD becomes its own account.
  4. As each CD matures, reinvest into the longest term on your ladder. For example, on the less aggressive plan from step two, when your 6-month term matures, you'd reinvest it in a 30-month term. Then, six months later, your 12-month CD will mature, and you can again reinvest it into a 30-month CD. Continue to do this as each CD matures, and soon your CDs will all be on long-term maturities, earning the highest rate but coming up for maturity on a staggered schedule.
  5. If you need cash, withdraw the portion that matures next. In the 6-month example, every six months, a portion of your savings becomes available, and you can choose to keep the cash and not reinvest. When you open the account, be sure to ask about auto-renewals, as some CDs automatically renew into a similar CD when they mature unless you take some action.

It's worth noting that, when starting your ladder, you will earn a little less in interest than you would by investing the full amount immediately into the longest-term CD--but the ladder method will protect you against losses should you need to break a CD for short-term cash needs before it matures. And if interest rates suddenly go higher, you can slowly roll over your savings into new CDs of those higher rates rather than having your entire savings locked into a single interest rate for years.

Also, when you are checking rates on CDs, also look into high-interest savings accounts, as well. Sometimes the APY for high-interest savings accounts is actually higher than it is for shorter-term CDs.

Finally, if you decide to use a CD ladder, make sure you complement that strategy with a standard savings account, which is liquid at all times. This will further reduce the risk of having to withdraw CD funds before maturity if unexpected expenses arise.