CD laddering is a strategy that allows savers and investors to take advantage of both short- and long-term interest rates on certificates of deposit (CDs). Because CDs typically require you to tie up your money for several months or years, a CD ladder with different maturity dates can allow you to enjoy higher interest rates without restricting access to your funds.

If you're thinking about using CDs to earn a guaranteed rate on your savings, but you're unsure about the potential downsides of a long-term CD, here's how to set up a CD ladder strategy to your advantage.

What is a CD ladder?

A CD ladder is a personal finance savings strategy that spreads deposits across multiple CDs with staggered maturities instead of investing all your funds in a single CD with one set term length.

Long-term CDs and short-term CDs often offer higher annual percentage yields (APYs) than traditional savings accounts. Locking in a better rate can be appealing, especially if you anticipate that interest rates will drop soon, allowing you to earn a higher rate of return.

But squirreling away your savings for several years may not be an option for some. At the very least, it's an inconvenient option — withdrawing your money before the account matures can result in steep early withdrawal penalties.

Using various CD term lengths, you can get the best of both worlds: higher APYs on long-term CDs and quicker access to funds on short-term CDs.

How does CD laddering work?

The amount of money you have to set aside in CDs can help you shape your CD laddering strategy. While the banks with the best CD rates often offer multiple terms, they may also have minimum deposit requirements.

As an example, let's say you have $10,000 to save, and the bank you're working with has a $2,000 minimum deposit for its CD accounts. Here's a quick example of how you might structure your CD ladder, with total returns calculated with compounding monthly interest:

Each time one of your CDs matures, you can reinvest it by opening another five-year CD, ensuring that you'll always have one CD maturing each year.

Interest rates don't necessarily increase significantly with each additional year. However, the ability to lock in a higher rate for a longer period of time can benefit you in the long run, particularly if interest rates go down on new CDs.

Pros and cons of CD ladders

Before you decide to utilize the CD laddering strategy, it's important to understand both the advantages and disadvantages of the approach. Here are some things to keep in mind.

Pros

• You can lock in high APYs with both short-term CDs and longer-term CDs, especially if interest rates are forecasted to drop

• You'll be able to improve your liquidity through short-term CDs

• If interest rates rise, you can take advantage of the new rates as your short-term CDs mature

Cons

• If interest rates fall, reinvesting funds from maturing CDs may result in lower returns

• A large chunk of your money may still be inaccessible for a long period of time

• CD rates usually don't keep up with inflation, so you may be able to get a better return elsewhere

How to set up your CD ladder strategy

Once you get the hang of it, building and maintaining a CD ladder is relatively straightforward. Here are some steps you can follow to get started.

1. Shop around for the best rates

Each bank and credit union has its own set of CD rates and terms, so you'll want to find the financial institution that offers the best CD rates for you and your situation. And keep in mind that some banks and credit unions may offer excellent rates on shorter terms and less-than-stellar rates on longer terms.

The best rates for shorter-term CDs might be at a different bank or credit union than the ones offering the best long-term rates.

As you research and compare your options, pay special attention to the following features:

• APYs for each term you're interested in using

• Minimum deposit requirements for each account

• Early-withdrawal penalties

Also, keep in mind that some CDs may offer special features, such as promotional rates for a few months, no-penalty withdrawals, or the ability to bump up the rate or add another deposit after opening the account. That said, these CDs typically offer lower APYs than standard fixed-rate CDs.

2. Determine your strategy

Determine how many CDs you want to open and which terms you feel comfortable with. While we use one-year increments in our example above, you can determine your own cadence for maturity — some banks offer terms ranging from one month to 10 years, depending on your needs.

If you anticipate needing any of the money you're planning to save in the near term, consider shorter terms to start. But if you truly won't need the money and want to keep it somewhere safe, you may be able to go for longer terms.

3. Open the initial CDs

Once you've figured out how to set up a CD ladder strategy, open the accounts with your chosen bank or credit union.

Remember, once you open the accounts and deposit the funds, you typically won't be able to access them again until the CD matures unless you want to pay an early-withdrawal penalty. So, only open an account once you're ready to commit.

4. Cash out or reinvest your money once each CD matures

Depending on your situation and needs, you may decide to cash out each CD as it reaches maturity or reinvest it, matching the longest initial CD term. You'll keep doing this each time a CD matures until you're ready to stop completely.

Financial institutions typically set CDs to renew automatically, but you'll typically get one to two weeks to withdraw the money — known as the grace period. You can hold on to the funds or put them toward a new CD before they become unavailable again.

5. Make adjustments as necessary

Adjust your CD laddering strategy as needed depending on your need for liquidity and interest rate fluctuations over time. Today's best CD rates won't necessarily be the same as the best rates six months or a year from now, so reassess your approach over time. For example, you may decide that you're ready for longer terms or realize that shorter terms are better for you.

It's also important to consider the direction interest rates are moving. Adding new CDs may not be as appealing as other ways to invest your money if rates are going down. But if interest rates are on the rise, you may want to increase your deposits with new CDs.

Alternatives to CD ladders

Based on your situation and need for liquidity, there are several alternatives to the CD laddering strategy to consider before you proceed. Here are just a few to compare.

1. High-yield savings accounts

A high-yield savings account (HYSA) offers much higher APYs than traditional savings accounts, and some banks and credit unions offer rates comparable to what you can get with a long-term CD.

A high-yield savings account is worth considering if you always need access to your funds. However, your APY is variable and will fluctuate over time.

2. Bond funds

Bonds don't offer the guaranteed returns of a CD, but if your goal is to avoid the volatility of stocks and other investments, bonds can provide a relatively safe return. Sometimes, they can offer higher returns than you'd get with a CD.

Bond funds typically charge fees, which eat into the return you get on your money. And while they're less risky than other types of investments, there's still some risk involved.

3. Dividend stocks

Dividend stocks pay dividends to their investors, providing regular income and the potential for price appreciation. Companies that pay dividends to their shareholders are typically well-established and have less price volatility than stocks that don't pay dividends.

That said, you're still investing in stocks, which are susceptible to both company-specific and market risks. If your priority is to keep your money safe, there may be better ways to go than stocks.

4. Money market accounts

Money market accounts (MMAs) are deposit accounts used to build savings and earn interest. Like savings accounts, you can continually add funds as you save for your goals.

Generally, money market accounts pay higher APYs than traditional savings accounts, and some online banks offer even higher APYs that are roughly 10 times the national average for savings accounts.

Unlike savings accounts and CDs, money market accounts are much more accessible with check-writing privileges and debit card access. However, there are usually limits on how many withdrawals or transfers you make per month, and your bank or credit union may charge you added fees if you exceed that number.

FAQs

Is my money protected in CDs?

Yes, like other deposit accounts, your CD is typically federally insured, either through the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA). FDIC-insured and NCUA-insured funds are covered up to $250,000.

What happens if I don’t withdraw my funds after the CD’s maturity date?

When a CD matures, your bank or credit union will give you a grace period of several days past the maturity date. You'll need to decide whether to withdraw your funds from the CD or or roll it over into a new CD, ideally one with a higher APY if poddible. In most cases, if you do not withdraw your funds and the grace period passes, your bank or credit union will automatically renew the CD.