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Climbing the CD Ladder

Certificates of deposit (CDs) are a type of savings tool that offer higher returns than savings accounts, money-market accounts, and interest-bearing checking accounts but at the cost of locking away your money for anywhere from three months to ten years, with a penalty for withdrawing money early. The longer the CD’s term and the larger the deposit, the higher the interest rate. However, interest rates could rise while your money is locked in a CD, meaning you wouldn’t be able to take advantage of the new rate.

But there is a way to take advantage of a CD’s higher annual percentage yield (APY) and still maintain access to your cash for emergencies or other investments. Say hello to CD laddering.

A CD ladder is a method of setting up multiple CDs that mature at staggered intervals, allowing you access to part of your savings on a regular basis while keeping the rest in high-yield, longer-term CDs. When a CD matures, you have the choice to reinvest in another CD, or use it for another investment or an expense.

For example, let’s say you have $15,000 in savings. You could keep $5,000 in a traditional savings account for easy access and invest the remaining $10,000 in five tranches—five CDs of $2,000 each with five different maturity terms: a five-year, a four-year, a three-year, a two-year, and a one-year.

When the one-year CD matures, you can reinvest it as a five-year CD, repeating the process so that within five years, all of the CDs will be invested at five-year terms (and the higher interest rate), but one will still be maturing each year, giving you the opportunity to withdraw the money without paying a penalty. You can also add to the CD when it matures, and you can always create more tranches, perhaps having one mature every six months but still at the five-year term rate. There is a lot of flexibility when it comes to building a ladder.

CD ladders are a great way to create stability in your savings and investment portfolio and to build a safety net against riskier investments. While the APY is not as high as riskier investments, CDs are stable and not in danger of losing their value. Holdings up to $250,000 per person are insured by the NCUA against loss.

If you think a CD ladder might be a smart move for you, start simple, with only a few mid- to short-term tranches until you’re comfortable with the CD maturing process. The key is to stay on top of the tranche rotation and when each CD matures. You can set up automatic reminders to re-asses your financial needs before each CD matures to see what you’d like to do with the money. As a reminder, you will have to pay income tax on the interest you earn from your CDs, even if you don’t withdraw the money.