What is a CD Ladder?

A certificate of deposit ladder, or CD ladder, is an investment strategy in which the high rates of a long term CD are combined with the availability of a short term CD. It involves multiple CDs taken out at different terms and subsequently renewed to the maximum term. For example, a five year CD is taken out along with a four, three, two, and one year CD at their respective rates. As each one of the CDs matures, they are renewed to five years at the current rate. For the next five years, the CDs will mature each year, yielding the maximum rate.

Generally, longer term CDs have a higher rate of return than short term CDs. A five year CD might have a yield of 3.0%, while a one year CD will have an interest rate of 0.9%. Shorter term CDs allow investors to access their money quicker, but the return is smaller. Long term CDs allow investors to receive a high rate of return, but they can't access their money for several years.

One reason for building a CD ladder is to avoid penalties for withdrawing money before the CD matures. The above example allows investors to withdraw yearly. Other CD ladders allow investors to withdraw monthly.

Staggering the initial CDs provides investors with the opportunity to withdraw money yearly. Investors can withdraw as much as they like before renewing the CD to the maximum term. As long as the minimum deposit requirement is met, the CD ladder will develop.

The first CD to mature in the above example is the one year term CD. When it matures, investors can withdraw as much as they like and then renew the remaining balance to five years. A year later, the two year term CD will mature. Again investors can withdraw money and then renew it to five years, instead of the current two years.

Similarly, a year later, the three year term CD will mature and investors can leave the money or take some out. The key is to renew it to five years instead of three. In the fourth year, the same thing is done. By the fifth year, the five year term CD has matured. It should be renewed for another five years.

In years 6-10, the investor will have five year term CDs that mature yearly. Both the availability of a short term CD and the return rate of a long term CD is achieved. Investors can build a CD ladder that takes several years to develop, like the above example, or one that takes several months.