A CD, or certificate of deposit, is often thought of as a low-risk investment, but you have to lock away your money for a period of time. You can buy short-term CDs that mature in six months or one year, but you’ll likely miss out on the best interest rates available. The highest rates are generally paid out on longer-term CDs, such as three-year or five-year CDs.

What if you could enjoy the higher annual percentage yield (APY) of a long-term CD without parting with all of your funds for years at a time? That’s where a CD ladder can come in handy.

• What is a CD Ladder?
• Is a CD Ladder a Good Idea?
• Can you Lose Money on a CD?
• How Much Money Should you put in a CD?
• What are Some Mistakes to Avoid When Investing in CDs?
• How to Build CD Ladders
• How do I Choose a CD?

What is a CD Ladder?

A CD ladder is a strategy in which an investor divides a sum of money into equal amounts and invests them in certificates of deposit (CDs) with different maturity dates. This strategy decreases both interest rate and reinvestment risks.

A CD is an investment product that offers a fixed interest rate for a specified period of time. The invested funds, which are insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC), are locked in by the issuing bank until the maturity date of the CD.

Read Also: Investing for Retirement: The Complete Guide

Maturity dates for these savings instruments are typically set at three months, six months, one year, or five years. The higher the term for which funds are committed, the higher the interest paid. To take advantage of the various interest rates offered for different time periods, investors can follow a strategy known as the CD ladder.

Is a CD Ladder a Good Idea?

While a CD ladder strategy works for some people, it won’t work for everyone. It all comes down to how you feel most comfortable saving. Some things to consider:

• You can’t change rungs once you put your cash down. If something happens where you need your money before the CD term is up, you may have to pay penalties for taking it out early. If you need even more flexibility and access than a CD ladder can provide, a savings account might be more your style.
• On the other hand, CDs are typically FDIC insured, meaning your cash will be covered up to the limits you qualify for. And since you lock in your interest rates, a change in the economy or outlook from the Fed won’t affect your future savings.

Because there are so many different choices with CD ladders, your best option might be to check with an expert to see what opportunities are available and which CD ladder strategy (if any) is right for you. Remember, no matter where you end up investing, set your savings goals high so that you’ll need a ladder to reach them.

Can you Lose Money on a CD?

CD accounts held by consumers of average means are relatively low risk and do not lose value because CD accounts are insured by the FDIC up to $250,000. Taking an early withdrawal from a CD account can result in getting less money than you invested, though such losses are not considered “losing value.”

CDs provide account holders with interest rates that are generally higher than average savings and checking accounts, which is why some consumers opt to open them.

Typically, you can open a CD account with a minimum of $1,000. CD account terms can range from seven days to 10 years, depending on the amount of money deposited. Banks allow you to renew or close a CD account upon its maturity.

You can usually withdraw the interest earned on a CD at any time without penalty, but you must pay a penalty fee when you withdraw part or all of the principal before the maturity date.

Investors with a higher risk tolerance can buy CDs from brokerage firms or salespeople other than banks or credit unions. Called brokered CDs, they are technically not FDIC-insured (though the broker’s underlying CD purchase from the bank is) so they can be risky.

Principally, licensing and certification are not required for deposit brokers, so you should exercise due diligence and research anyone claiming to be a deposit broker before you choose to open a brokered CD.

There are several other forms of CDs as well. These include the bull CD, bear CD, and Yankee CD. While a bull CD offers a minimum interest rate relative to the performance of a market index, the interest rate paid by a bear CD varies depending on whether the market index moves lower.

Bull and bear CDs can offer higher interest rates than traditional CDs and are considered to be relatively conservative investments, but they are not insured by the FDIC. Lastly, a Yankee CD is a CD issued by a foreign bank for American investors and, like bull and bear CDs, is not directly insured by the FDIC.

How Much Money Should you put in a CD?

Managing a household budget can prove tricky, and while much of your income might pass straight through your accounts to your daily and monthly expenses, you should aim to maximize what remains by creating a savings plans. Certificates of deposit are a type of conservative long-term savings account.

The interest rates on CDs are usually higher than on basic savings accounts, but most banks have rules that prevent you from having easy access to the money.

Also, in the long-term, CDs do not tend to offer the same kind of growth potential as stocks and other securities. Carefully think about a number of factors, including your short-term costs and long-term plans, before you invest in CDs.

Buckets

Financial planners often produce charts for clients in which the client’s financial assets are divided into three buckets: short-term, mid-term and long-term. Typically, advisers recommend keeping between three and six months of living expenses in highly liquid accounts such as your checking or savings account.

You can readily access this money when your car breaks down, you lose your job or experience some other type of calamity. The long-term bucket holds the money you plan to invest for a decade or more and these funds might form part of your retirement plan or even cover college costs if you eventually have kids.

The mid-term bucket contains money that you do not need now but do not want to tie up long-term. CDs are instruments that belong in the mid-term bucket, so once you’ve divided your money into these three increments, you will know how much you can consider investing in CDs.

Risk

CDs available through banks are guaranteed by the Federal Deposit Insurance Corporation. This means that if your bank fails, the FDIC will cover up to $250,000 of your money. The National Credit Union Administration provides the same coverage for CDs held through credit unions.

If you are wary of a bank failure, then split your money between several institutions to ensure that you remain under the FDIC or NCUA cap at each institution. You can further extend your coverage by acquiring bank-issued CDs through an investment company and holding those CDs in your brokerage account.

Banks

Banks use CD money to fund lending and consequently banks take steps to reduce the likelihood that CD clients will remove their funds before the end of the CD term. Institutions may assess penalty fees or withhold your interest if you withdraw your funds prematurely.

Additionally, banks typically pay tiered interest rates on CDs which means that the more you invest in a CD the more you stand to earn in interest. Your bank’s minimum balance requirements, interest rate tiers, and withdrawal penalties should have a major influence on decisions related to the size of your investment.

Considerations

CDs are not ideal investments for everyone, so these products do not necessarily have to form part of your investment portfolio. If CDs appeal to you but you are wary of tying up your money, you can ask financial institutions about so-called no-risk CDs.

These accounts work similarly to standard CDs except that you can make penalty-free withdrawals prior to the end of the term. If you can access your money with minimal restrictions then decisions about the size of your investment are much easier to make.

Be careful not to lock up too much money

Investing in CDs may seem like a good idea. There’s a guaranteed rate of return and an opportunity to boost your savings if you hold onto the account until it matures.

Since it’s difficult to say what the future will bring in terms of Federal Reserve interest rate cuts, worried consumers may prefer locking up money in a fixed-rate CD as opposed to possibly seeing variable saving and money market account rates decline further.

Having a jumbo CD, however, comes with its own risks as well. Rates at the moment are keeping pace with inflation, but that could change over time, reducing the value of your money.

Another issue: Insurance provided by the Federal Deposit Insurance Corp. and the National Credit Union Association is limited to $250,000, per depositor, per insured bank, per ownership category. Someone hoping to put more than a quarter of a million dollars in a jumbo CD runs the risk of not getting some of their money back if their bank fails.

Interest attained by investing in jumbo CDs is also taxable, presenting an additional problem for savers hoping to protect their earnings.

“If the jumbo CD is not held in a tax-deferred retirement account, taxes from interest will dampen the return and purchasing power even more,” says Alano Massi, CFP, managing director for Palm Capital Management in Westlake, California.

What’s more, once you tie up your money in a jumbo CD, you’re stuck until it comes due, unless you don’t mind paying an early withdrawal penalty. But let’s face it: You could lose a lot of money in the process of cashing out a CD of $100,000 or more before the end of your term.

What are Some Mistakes to Avoid When Investing in CDs?

A key advantage of investing in CDs is that the FDIC insures deposits at member banks and credit unions up to the maximum amount allowed by law. However, as secure as a CD is, there are some common mistakes to avoid that could cost you thousands.

1. Not shopping around for the best CD rate

You’ll find a great range of CDs available from financial institutions today — but they differ in important ways. APYs aren’t standard and usually depend partly on the length of the CD term.

You’ll want to check current rates and minimum deposits, but also be aware of charges for early withdrawals, automatic renewals, penalties, upfront fees or other requirements that can limit you and cost you money. 

Be aware that some banks reserve the right to change the rate on your CD investment on short notice — it’s important to read the fine print. Shopping around ensures you’ll find the best vehicle for your money with great rates, loyalty rewards and more. 

2. Choosing the wrong CD term

With CDs investments, you are stashing away a specific amount of money for a set period of time without touching or spending it. In return, you earn higher interest than with a conventional savings account.

The trick is determining if you want your money in a short-term CD fewer than 12 months, in a mid-term CD between one and three years or in a long-term CD over three years. Choose wrong, and you may be looking at early withdrawal penalties that soak up any interest you may have earned.

Most 12-month CD rates are currently averaging 1.50% APY. Long-term CDs, like 60-month cd rates, are closer to the 1.75% mark if you’re willing to put some money away for 5 years.

3. Putting all of your money in a single CD

If you’re worried about not being able to access your money in an emergency, consider placing it in several CDs with different maturation rates, rather than all in one. For example, if you have $15,000, put $5,000 each in a one-, three- and five-year CD.

When each one matures, you can roll it into a new five-year CD with a different maturation date, knowing that every two years, one of your CDs will mature and provide you with funds you can use or reinvest. Once all your money is invested in longer-term CDs, you’ll also earn significantly more interest than you would with shorter-term options.

4. Putting the wrong money into CDs

CDs aren’t the only vehicle for letting your money work for you. If you can afford to commit your money for five or 10 years, many advisors suggest you consider stocks. One factor is how comfortable you are with risk.

CDs are low-risk, with a fixed rate that’s guaranteed. Stocks may rise or fall significantly, and you’ll need to ride the ups and downs while waiting for long-term growth.

Another investment tool is money market accounts, which are very similar to a savings account, but usually require very high minimum deposits. You can still withdraw money from an MMA without penalty, but typically cannot let the balance fall below a certain threshold.

If you believe you’ll need the money before the end of a CD term, try a different investment method instead.

5. Letting your CD automatically roll over

One of the most costly mistakes people can make when choosing a CD is failing to read the small print where it says your CD will automatically roll over at maturity. Your money, including the original deposit and any interest earned, will be rolled over into a new CD account for another predetermined term.

There are other drawbacks. You might not be eligible for the same interest rate with the new CD, and you risk being locked into another CD term you might not want. Before you sign up for your CD, check and see what the institution does at the end of the CD’s term — and consider opting out if that does not fit your plan.

6. Ignoring the Fed

In a slow economy, the Fed may lower interest rates to spur growth. If the economy is growing too fast, however, the Fed raises rates, which causes businesses and consumers to spend less.

When the Fed cuts rates, banks lower APYs on CDs, and your interest earnings will fall. So it pays to watch the Fed and open CDs during periods when rates are higher.

7. Withdrawing money from a CD before it matures

When you open a CD, you promise to leave your money in the bank for a designated period of time. If something comes up and you need to withdraw that money, you’ll pay a penalty, which is usually several months’ worth of interest, or more.

CDs that allow penalty-free withdrawals generally come with lower interest rates. Depending on the type of CD term, withdrawal penalties can range from 60 to 365 days of interest so make sure to factor that into your plans when taking opening a CD.

CDs offer a low-risk vehicle for earning money through competitive interest rates. They’re especially useful if you can afford to have your money tied up for several years. But not all CDs are created equal: by shopping around, you can find the best rates, along with a term period that works for you.

Investing in multiple CDS with varying interest rates is a great way to have access to your money at regular intervals, which you can do by laddering your CD maturation dates.

How to Build CD Ladders

It’s not particularly difficult to build a CD ladder. You may be able to do it on your own by opening CDs of varying terms. Many banks even let you complete the process online. If you need additional help, a banker or broker may be able to create a CD ladder for you.

To design your ladder, you’ll have to decide on the overall length of your ladder (or the duration of the longest-term CD) and the length of time between each CD’s maturity date.

While staggering maturity dates by one year is common (as modeled in the scenario above), you could set your CDs to mature at intervals of your choosing—every six months or two years, for example. Regardless of the length, when you create a CD ladder you’ll initially have to purchase shorter-term CDs, such as those with one- or two-year terms.

If you don’t expect to need the money on short notice, a less frequent maturity cycle could be appropriate when you create your CD ladder.

However, if you need a portion of the money quickly (let’s say that a financial emergency hits), shorter maturity intervals would give you more frequent access to some of the funds and could spare you from an early withdrawal penalty.

One of the great things about CD ladders is that they can come in all shapes and sizes. You can adjust the length, or term, of the CD ladder and the frequency by which it matures to match your financial goals, like building up your emergency savings or prepping for a big-ticket purchase.

Emergency fund

You can use a CD ladder as an emergency fund by structuring it to mature in monthly increments and putting an average month’s expenses in each CD. You can reopen CDs as they mature, or the bank may be able to automatically open them for you. Hopefully, emergencies rarely arise.

But when one does, you’ll have a steady stream of maturing CDs to cover your expenses. That said, even if you use a CD ladder to save for emergencies, it may be worth setting aside at least a portion of your emergency stash in a checking account or savings account for quick access.

Big-ticket purchase

Your approach may be different when creating a CD ladder for a specific purchase. Perhaps you’re planning on buying a car in five years but you are not comfortable locking up all of your new-car savings for 60 months.

You could build a CD ladder in the same way you would for more general savings outlined above, but when your CDs mature, you wouldn’t reopen five-year CDs.

Instead, you would open CDs that mature within your savings time frame. If you are still four years away from the new set of wheels, for example, your new CD could have a 48-month term. If you are three years out, 36 months, and so on.

College expenses

You could also create a CD ladder to help cover college expenses and time it so that a CD will mature at the start of each semester or school year. Or, as your child nears college—perhaps three or five years out—you could build a CD ladder to help keep their education fund growing and secure.

When determining how best to create a CD ladder to meet your financial goals, consider the current interest rate environment. For example, in an environment where interest rates are expected to drop, Stack says it might make more sense to lock in the current interest rate with long-term CDs than to create a CD ladder.

Lowe seconds this opinion. “When rates are expected to stall or drop, CD ladders can cost you money,” she says. In this scenario, each time one of your CDs matures and you put your funds back into a CD, you could be locking in a lower interest rate.

A certificate of deposit can be a dependable financial tool that may work well if you’re looking for a low-risk way to save your money and earn a predictable return. However, locking your money up could mean taking on liquidity and interest-rate risk.

Building a CD ladder can help boost your returns while limiting the potential drawbacks. So, while your fabled money tree is (sadly) unlikely to ever materialize, growing your money with a CD ladder is about as good a trade-off as they come.

How do I Choose a CD?

The traditional certificate of deposit is far from being the only CD product available to savers. Financial institutions offer a variety of CDs, giving savers more flexibility to manage their money when the economic winds change and interest rates rise or fall.

Specialty CDs give savers more flexibility to take advantage of better rates, shield themselves when interest rates are falling and provide easier access to their funds without penalty. Carefully consider which type of CD is best for you.

1. Traditional CD

With a traditional CD, you deposit a fixed amount of money for a specific term and receive a fixed interest rate. You have the option of cashing out at the end of the term or rolling over the CD for another term.

Penalties for early withdrawal can be stiff and will erode your earnings, and possibly your principal. Those fees must be disclosed when the account is opened.

Before you pick a CD, calculate how much interest you could earn by the end of its term.

2. Bump-up CD

A bump-up CD helps you benefit from a rising-rate environment. Suppose you open a two-year CD at a given rate, and six months into the term your bank raises its APY on that product.

A bump-up CD allows you to tell your bank you want the higher rate for the remainder of the term. Institutions that offer bump-up CDs usually allow only one bump-up per term.

The drawback is you typically get a lower initial APY on a bump-up CD than on a traditional CD, so when rates rise, you’ll be catching up. Be sure you have realistic expectations about the interest rate environment before buying a bump-up CD. See how bump-up CDs stack up against traditional CD rates.

3. Step-up CDs

Like a bump-up CD, a step-up CD will help you move up to a higher yield. But unlike a bump-up CD, you don’t have to ask the bank for the higher rate; rather, a step-up CD rate rises automatically at certain intervals during the term.

Step-up CDs are not too common, however, and there’s no guarantee that you would earn more than a traditional CD. The blended APY might be less than a traditional CD. As such, you’ll want to evaluate the starting APY, as well as how much the rate is increasing, before choosing this product.

4. Liquid (or no-penalty) CD

Liquid CDs, or no-penalty CDs, allow investors to withdraw their money before the CD term ends without incurring a penalty. The APY tied to a liquid CD may be higher than the yield on a savings or money market account. But it will likely be lower than the rate of a traditional CD of the same term.

You’ll have to weigh the convenience of liquidity against whatever return you’re sacrificing. A key consideration with a liquid CD is how soon you can make a withdrawal after opening the account.

Most banks require that the money stay in the account for at least seven days before it can be withdrawn without penalty. But financial institutions can set their own penalty-free withdrawal rules, so it’s important to read the fine print before opening a liquid CD.

5. Zero-coupon CD

With zero-coupon CDs, you buy the CD at a deep discount to its par value, which is its value at maturity. “Coupon” refers to a periodic interest payment. “Zero-coupon” means there are no interest payments.

So, you might buy a 10-year, $100,000 CD for $50,000, and you wouldn’t receive any interest payments over the CD term. You’d receive the $100,000 face value when the CD matures in addition to the accrued interest.

One drawback of zero-coupon CDs is that they are usually long-term investments and you don’t earn any money until the CD matures.

Another drawback is that you’re credited with phantom income each year. No money is being put in your pocket, but you’ll have to pay taxes on the earnings being accrued. Each year, you’ll have a higher base than the year before — and a bigger tax bill. Make sure you can afford to cover the taxes.

6. Callable CD

With a callable CD, there is a chance to earn higher interest, but there is a risk: Usually, banks pay higher APYs for savers to take that risk. But if rates fall, your financial institution can “call” back the CD before it matures and reissue it to you at the new, lower rate.

For instance, if you take out a five-year CD at 2 percent APY and six months later rates drop by a full percent, the bank will lower its rate, too, and call back your higher-rate CD. You’ll receive your full principal and interest earned, but you’re stuck reinvesting your money at a lower rate.

When you’re seeking a higher yield, you might look to invest in a callable or zero-coupon CD. But consider the downsides and economic conditions when considering these types of CDs.

7. Brokered CD

A brokered CD is sold through a brokerage firm. To get one, you need a brokerage account. Buying CDs through a brokerage can be convenient. There’s no need to open CDs at a variety of banks to get the best yields. Some banks use brokers as sales representatives for the banks’ CD products.

Brokered CDs may pay higher rates than CDs from your local bank because banks offering brokered CDs compete in a national marketplace. But that’s not always the case.

Brokered CDs are more liquid than bank CDs because they can be traded like bonds on the secondary market. But there is no guarantee you won’t take a loss. The only way to guarantee getting your full principal and interest is to hold the CD until maturity.

Don’t assume all brokered CDs are backed by the Federal Deposit Insurance Corp. It’s up to you to find out. You should also watch out for brokered CDs that have call options. And before you invest, check on fees and early withdrawal policies.

8. High-yield CD

Banks compete for deposits by offering better-than-average rates. High-yield CDs are generally traditional CDs that pay better returns.

Bankrate offers the best route for finding the highest rates in the nation. Bankrate surveys local and national institutions to find banks offering the highest yields on CDs. All accounts are directly offered to the consumer by the institution.

Take time to compare the best CD rates. Then calculate your potential earnings.

9. Jumbo CD

Just as its name implies, a jumbo CD requires a larger deposit than a traditional CD — typically, $100,000. In some instances, the deposit requirement is somewhat lower. Jumbo CDs may or may not pay more than a traditional CD.

The average rate on a five-year jumbo CD is 0.57 percent, while the average rate on a five-year CD is 0.55 percent as of July 8, according to Bankrate’s national survey of banks and thrifts.

With a jumbo CD, there’s a risk of whether the account will keep up with the inflation rate. And don’t forget that the interest you earn will be taxed as ordinary income.

10. IRA CD

An IRA CD is a CD that is held in a tax-advantaged individual retirement account. IRA CDs may appeal to the risk-averse who want to build their retirement savings with guaranteed returns.

You will also have the protection of up to $250,000 if you purchase IRA CDs from an FDIC-insured institution. The trade-off is that you won’t make high returns on these investments.

While they can help you diversify your portfolio, IRA CDs are not generally viewed as smart retirement strategies for younger investors who can take on more risk. To get the most out of an IRA CD, fund one with the money you won’t need until age 59 1/2, so you don’t have to pay a tax on early distributions.

11. Add-on CD

With most CDs, you make only the initial opening deposit and you cannot add to it during the term. But add-on CDs let you deposit more money into the account during the CD term, like a savings account. However, the number of additional deposits you can make with an add-on CD varies, so be sure you read the fine print.

12. Foreign currency CD

Foreign currency CDs are not for novice or risk-averse investors. They are complicated. They can be issued in euros, British pounds and other foreign currencies.

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They are bought with U.S. dollars and are converted back to dollars when the CD matures. There is no guaranteed APY because the interest is based on foreign currency or a basket of foreign currencies.

While the investor in foreign currency CDs may be able to get higher returns, currencies and global economic conditions fluctuate, creating risk. There are also risks when you convert the foreign currency CD back to dollars. A strengthening dollar can wipe out your return.

These CDs may not be FDIC-insured. To qualify for FDIC insurance coverage, the principal amount you invest must be guaranteed by the issuing bank. “If the principal is subject to lose — other than for an early withdrawal penalty — the product is not insured by the FDIC if the bank were to fail,” the FDIC explains on its website.

Conclusion

A CD ladder can help you build a predictable investment return. It also gives you the ability to earn better returns than you would on a single short-term CD, as well as the ability to access a portion of your CD savings each year.

The tradeoff is you could risk losing to inflation in the long term. Plus, you’ll potentially lose out on better returns offered by other investment vehicles with greater growth potential.

Consider your reason for opening a CD ladder before moving forward. It could be a great fit for your short-term savings goals. But a long-term savings effort might need an additional boost from other investment vehicles.