How It Works
Laddering is based on the concept of not putting all your eggs in one basket, or in this case, all your money in one CD. The idea is to purchase multiple CDs that spread your redemptions and renewals over time to take advantage of changing market expectations. By blending the interest rates on multiple CDs, you reap the immediate benefit of earning interest at an average yield that is higher than the shortest-term CD in your ladder. So the interest you are accruing is greater than it would have been if you had purchased a single, short-term CD. Generally, the CDs are purchased with maturity intervals of six or twelve months.
Example of CD laddering
Let’s assume that you have $10,000 to invest. As a general rule, longer term CDs offer a higher interest rate, but your money is locked up for whatever period you select. Rather than buying one five-year CD for $10,000, you buy a one-year CD for $2,000, a two-year CD for $2,000, a three-year CD for $2,000, a four-year CD for $2,000, and finally a five-year CD for $2,000. The term “laddering” is a reference to the concept that each year in this strategy represents one rung on your investment ladder.
When the first CD matures after one-year, you take the proceeds and reinvest them in a new five-year CD to replace the original five-year CD which now only has four years until maturity. When the two-year CD matures a year later, take those proceeds and buy another five-year CD, and repeat the process for the subsequent CDs when they expire. By using this approach, you will have one CD maturing every year, giving you access to one-fifth of your capital on a revolving basis. This avoids having all of your money tied up for a five-year period, and allows you to sequentially reinvest the $2,000 increments at prevailing longer-term interest rates.
Video: How Does a Certificate of Deposit Work?
CD Ladder chart
The illustration below depicts how a CD ladder might be set up. The “1 year” title denotes a CD with a one-year maturation period, followed by CDs with 2, 3, 4, and 5 year periods. Note that after the fifth year, all of your money will be invested in CDs with five-year terms that will typically feature higher rates of return.
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2009 |
2010 |
2011 |
2012 |
2013 |
2014 |
2015 |
2016 |
2017 |
2018 |
CD #1 |
1 year |
5 year |
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5 year |
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CD #2 |
2 year |
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5 year |
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5 year |
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CD #3 |
3 year |
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5 year |
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5 year |
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CD #4 |
4 year |
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5 year |
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5 year |
CD #5 |
5 year |
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5 year |
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Benefits
Laddering a CD portfolio is similar to dollar-cost averaging with stocks. This is the process of spreading your purchases of CDs over a period of time to take advantage of interest rate changes, and to maintain liquidity and access to some portion of your cash. You avoid investing all your CD money at one rate of return from the outset. In addition, you realize the return that comes with guaranteed rate CDs and your principal is not exposed to the market fluctuations experienced by more risky investments such as stocks and mutual funds. With a CD ladder, you can’t lose money and you will never earn less than your anticipated gain when you opened your account.
You are also prepared to take advantage of future interest rate changes, in either direction. If interest rates go up, you can capitalize on this because a portion of your ladder is available to be reinvested every six or twelve months. If interest rates go down, you won't experience an immediate reduction in interest because several of your CDs will continue earning at the higher rates you previously locked in.
This type of investment is ideal for people who like the security of having some of their money available to them if they need it for an emergency. You decide how much and how often you want that money to be available. Unlike some other investment choices, there are typically no fees or other sales charges associated with these accounts.
Video: What Is a Certificate of Deposit?
FDIC coverage
All FDIC-insured financial institutions must meet rigid standards for strength and stability. If your insured bank fails, the FDIC will cover your deposits, including principal and accrued interest, up to $250,000 per depositor per insured bank. This includes checking and savings accounts, money market accounts, and certificates of deposit (CDs) up to the aggregate limit. For those who want the peace of mind in knowing that their investment money is safe, CDs provide an excellent means of protecting your capital while earning interest that will normally offset the effects of inflation.
Banks with highest yielding one-year CDs
Name/Annual Percentage Yield (APY)
GMAC Bank
Midvale, UT
3.75%
Pacific Mercantile Bank
Costa Mesa, CA
3.28%
Flagstar Bank
Troy, MI
3.25%
UmbrellaBank.com
Birmingham, AL
3.20%
First Internet Bank of Indiana
Indianapolis, IN
3.15%
Nationwide Bank
Columbus, OH
3.10%
Nexity Bank
Birmingham, AL
3.06%
EverBank
Jacksonville, FL
3.05%
Intervest National Bank
New York, NY
3.05%
Stonebridge Bank
Exton, PA
3.00%