A certificate of deposit (CD), a deposit account where the credit union or bank holds a fixed amount of money for a fixed period, is one of the safest ways to save and grow your money. However, limited liquidity is a drawback people cite against using CDs as an investment strategy. Do not let the fear of not having ready access to your money keep you from taking advantage of one of the best, low-risk investment options available. By using a CD ladder strategy, you can balance the trade-off between earning a higher return and having access to your money.
What are CD Ladders?
If you want to earn higher returns associated with CDs and a steady income stream, instead of placing all your eggs in one basket or CD, a CD ladder may be a better approach.
CD laddering is a savings strategy that divides your total investment into several certificates of deposit with different maturity dates. Using staggered maturity dates, when one CD matures, you get access to some of your money while still earning higher interest rates on longer-term CDs. This strategy allows you to access a portion of your money without breaking the entire CD and paying an early withdrawal penalty.
How Do CD Ladders Work?
Envision each CD as a rung of a ladder. The amount you invest and the CD terms on each rung can vary depending on your personal finances and savings goals. The longer-term CDs often offer higher interest rates, while the shorter-term CDs provide accessibility to funds as needed.
For faster access to emergency funds, a shorter-term CD is suggested for the first CD or the CD on the bottom rung of the ladder. The highest rung will hold the longer-term CDs. A commonly recommended number of rungs for a CD ladder is 5, giving you a mix of short-term CDs and long-term CDs.
Example of a CD ladder with a $20,000 investment divided into five equal parts:
- CD 1: $4,000 invested in a 6-month CD
- CD 2: $4,000 invested in a 1-year CD
- CD 3: $4,000 invested in a 2-year CD
- CD 4: $4,000 invested in a 3-year CD
- CD 5: $4,000 invested in a 4-year CD
When the 6-month CD matures, you can withdraw a portion of the funds and reinvest the remaining in a new 4-year CD. As each CD matures, it ‘falls off’ the ladder and then reenters at the top as a new longer-term CD, while the others ‘walk down’ the ladder. You maintain the ladder by continuously renewing the maturing CDs with a new CD. A general guideline is to invest an equal amount in each rung.
Alternatives to a CD Ladder
If you are still hesitant about opening a CD account, there are other types of accounts you can use as a saving alternative, including:
High-yield savings accounts. These accounts offer higher annual percentage yields (APYs) than traditional savings accounts but (for the most part) allow you access to your cash when needed. Account holders may need to maintain a minimum balance and are limited to a certain number of penalty-free withdrawals per month.
Money market accounts. A money market account (MMA) is similar to high-yield savings accounts but may require a higher minimum balance requirement. MMAs typically offer check-writing capabilities for easier access to funds.
Traditional savings account. If ready access to your money is critical, you cannot go wrong with a traditional savings account. Savings accounts offer higher interest rates than checking accounts, limit spending temptation and give you immediate access to emergency funds.
Is a CD Ladder Right for You?
If you meet the points below, a CD ladder may be right for you:
- Have money to invest
- Seek low-risk investment options
- Want a predictable stream of income
- Want to earn higher interest rates
TDECU offers CD terms ranging from 3-month CDs to 5-year CDs.