How to Create a CD Ladder

By Staff

The current era of historically low interest rates has been great for borrowers, but it stinks for those who’d rather save their money. I was fortunate to find a local bank that offered a money market account at 2.25% last year, but after a couple extensions, I received notice that “bonus rate” was expiring at the end of this month. The old rate was in the 1.0% APY range.

I could simply stash my emergency savings with ING Direct, but I prefer to keep a portion of the savings local. So, I’m off to find a way to boost my returns on local savings products.

So now I’m left to find a new home for some of our savings. Keep in mind this money is targeted for emergencies and short term (less than a year or two) goals. With everything else we are investing in dividend stocks and conservative life-cycle mutual funds inside Roth IRAs and my 401k.

Rather than leaving our money to languish at 1% interest, I would like to find a way to triple the earnings, without too much effort (after all, this isn’t “investing” money). Over the last couple weeks I’ve been investigating CDs.

I have to first confess, I’ve never owned a CD – mostly because up to this point I have never had enough money to invest in something that is locked up with a penalty for cashing out. Thankfully, that is beginning to change after our family recently reached debt freedom.

CDs may offer a slightly higher yield than I receive now from my local bank (and most online banks), however the requirement to tie up money for a number of years is not attractive to me. That was until I discovered the concept of CD laddering.

How to Ladder CDs

The real beauty of creating a CD ladder is that you don’t have to obligate your entire amount of savings into a 12-month CD to get a positive result. Instead, I recommend starting in the smallest increments you can tolerate and build from there.

Here’s an example using average rates collected from a number of CD offerings at Ally Bank, ING Direct,, and my local credit union. (I decided an average for each term would be easier than pinpointing a specific rate that could change before this article is even published). September rates are a wishful guess at what rates might look like by Fall, and were only changed to give you an idea why laddering could be a smart move given the idea rates will rise in the near future.

July Purchases ($2,000):

  • $500 3-Month CD matures in October 2010 (0.75%)
  • $500 6-month CD matures in January 2011 (1.15%)
  • $500 9-month CD matures in April 2011 (1.15%)
  • $500 12-month CD matures in July 2011 (1.50%)

August Purchases ($2,000)

  • $500 3-Month CD matures in November 2010 (0.75%)
  • $500 6-month CD matures in February 2011  (1.15%)
  • $500 9-month CD matures in May 2011  (1.15%)
  • $500 12-month CD matures in August 2011 (1.50%)

September Purchases ($2,000)

  • $500 3-Month CD matures in December 2010 (0.90%)
  • $500 6-month CD matures in March 2011 (1.25%)
  • $500 9-month CD matures in June 2011 (1.50%)
  • $500 12-month CD matures in September 2011 (1.65%)

*Note, I am using a 3-6-9-12 month maturity schedule to build a 12-month CD ladder. You could use a 6-12-18 month maturity schedule (or greater) to build an 18-month (or longer) ladder. A longer term ladder will earn higher rates, but will take longer to get going and will tie up your money for a longer period up front. It’s up to you to determine how much of your savings you can tie up, and for how long.

Beginning in October 2010, when our first 3-month CD purchase matures, I will use that original $500 (plus accumulated interest) to purchase a 12-month CD at a higher interest rate. In November, when the second 3-month CD expires, I’ll roll it into a 12-month CD purchase, and so on. In one year, I’ll have a rolling 12-month CD ladder of twelve one-year CDs.

One advantage of using these shorter terms is that when rates are rising, which I suspect they will be doing slowly over the next year or two, you can quickly take advantage of these new, higher rates without having to wait for a 6-month CD at a lower rate to expire.

Why Not Purchase 3-5 Year CDs At Higher Interest Rates?

If you lock into a CD for three or five years, you will miss out on interest rate increases. And this would be bad assuming they increase at a pace faster than the premium received for locking your money in longer.

It’s a bit of a guessing game – kind of like investing in the stock market. However, because these CDs represent a portion of my emergency fund (just a portion – not the entire thing), and funds for short-term goals, I’d rather have a little money coming back to me month-to-month, just in case.

Some lenders offer “penalty-free” CDs, which offer a lower interest rate for the option of cashing out without penalty before the CD matures. Personally, I’d probably go with the higher rate if my finances were sound with the understanding in a real emergency, I’d sacrifice a month’s interest as a penalty for accessing the money early.

Other lenders are offering what’s known as a “step up” CD. The Ally Bank Raise Your Rate CD is one such a product, which offers the ability to step up to a higher interest rate once during the term of the CD. It’s an interesting idea, but the minimum terms are typically longer than my liking.

CDs laddering seems to be something worth trying, and could be more profitable when interest rates rise again. I will go ahead and get the CD ladder in place now so that I will be ready to take advantage of higher interest rates in the future. If nothing else, I’ll earn a few more dollars on my savings for my troubles.