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The Basics of CD Laddering

  • July 18, 2022

If you’ve spent the past few years building up your savings and are now looking for a way to make the most out of your money, you’re in the right place. One of the best ways to do this is to open a certificate of deposit (CD) account.

But why stop at one! This blog will explain the ins and outs of a great investment strategy known as CD laddering. From what exactly this is to all its advantages, you’ll soon be ready to start building a CD ladder of your own and watch as your savings bucket continues to grow.

Let’s first define CD (Certificate of Deposit) vs. Certificate. CDs are found at banks, and Certificates are found at credit unions. They are both federally insured by the US government. FDIC backs banks, and credit unions are backed by the NCUA. For this article, we’re going to use the term CD mostly, but know that there’s no difference between CDs and Certificates.

What is CD Laddering?

If you’re unfamiliar with what a certificate of deposit is, let’s quickly recap. When you open a CD account, you’ll give your bank or credit union a lump sum deposit for a set amount of time. In return, you’ll benefit from a fixed interest rate premium until you withdraw the funds at the end of the agreed period.

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There can be early withdrawal penalties, so it’s best to use this type of account as a short-term investment. They’re much safer than stocks and bonds but still allow you to grow your savings with a guaranteed return. Shopping around for the best CD term interest rates before settling on one means you’ll get much more money back than what you originally put into the account.

So, what is CD laddering? This is a particular savings strategy where you put your money into several different CD accounts rather than a single lump sum into one CD account. Your funds will then be in accounts that are locked for various periods, usually anywhere from several months up to five years. The maturity date is known as the day that the CD account becomes unlocked or expires.

By staggering the different account maturity dates, you’ll have a constant stream of accessibility to that money as each expiration comes around. From there, you can either choose to reinvest those funds into another CD that ends after your furthest-out maturity date (adding another rung to your savings ladder) or keep it to use now.

The goal here is to take advantage of the best CD rates by locking in high annual percentage yields (APYs) across several different CDs, which means you’ll get more interest in your accounts.

How Does CD Laddering Work?

To build a CD ladder, you’ll need to decide how much money you want to invest. From there, you’ll open a handful of CD accounts simultaneously, each with different maturity dates.

Most people typically work on an annual basis. This means they’ll start with a CD account that lasts for one year. Then another matures in two years. Another matures in three years, and so on.

Let’s look at an example of this using real numbers. Say you have $25,000 in savings that you want to invest. You could split these funds into five different CD accounts, each with a progressively better level of interest – the longer you choose to leave the money in the account, the higher your interest rate will be.

With each CD account maturing in one-year increments, your investment plan could look like this:

  • $5,000 in a 12-month CD at 2.00% APY
  • $5,000 in a 2-year CD at 2.20% APY
  • $5,000 in a three-year CD at 2.30% APY
  • $5,000 in a four-year CD at 2.40% APY
  • $5,000 in a five-year CD at 2.60% APY

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At the end of the year, when each CD matures, you’ll have access to the original $5,000 that you invested, plus any interest that accrued during the lifetime of the account. If you choose to reinvest that money each time a CD matures, this creates a laddering effect as you move your reinvested money into a CD that goes to the back of the queue.

Building your savings ladder by repeating this over and over is a great savings strategy. You’re looking at guaranteed returns for double the term length of your original longest-term CD account. In this case, that would be 10 years of high-interest earnings on your $25,000.

You certainly don’t have to open a CD account that’s a minimum of 12 months, particularly if you think you might need access to those funds sooner. Look for California credit unions with certificate accounts that offer options for a “mini CD ladder”, using staggering maturity dates of several months up to a year.

Advantages of CD Laddering

CD laddering has plenty of benefits, particularly if you’re a cautious investor. Since CD interest rates are fixed when you open the account, they’re much lower risk than other traditional investment options. NCUA insures funds up to $250,000, and your CDs allow you to save money at a faster rate with guaranteed earnings, all while protecting your money against rising inflation.

Additionally, the short-term lengths of most CD accounts mean that you can take advantage of higher interest rates if these go up around the time your shortest CDs are maturing. You can reinvest those funds in a new, higher interest CD once the original term expires, which means even more money is added to your accounts.

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With your longer-term CDs, you’ll already benefit from the higher interest rates your bank or credit union offers. It’s their way of thanking you for depositing that cash for a longer period. But by using a laddering technique, you can keep building on those interest rates every time a policy matures.

Building a CD ladder also allows you access to your money at different intervals, which is great if you need cash quickly. As each of your CDs matures, you can choose whether reinvesting that money or keeping it for your everyday expenses is the best option. The staggered maturity dates mean you have a predictable flow of cash on hand, making planning for those funds much easier.

You might wonder what this level of flexibility and the best CD rates in California will cost you. The best news? Nothing! Unlike many investment alternatives, no management fees come with using a CD account, so you can take full advantage of the higher interest rates that these offer without handing over a single penny.

How to Build a CD Ladder

1. Decide How Much to Save and Invest

Before you open a CD account, decide how much money you want to set aside. It’s always best to keep some cash on hand rather than needing to rely on credit. Your emergency fund should be stored in a regular checking or savings account if you need access to those funds quickly. You should use a 401(k) or IRA account for longer-term goals like retirement.

Think of your CDs as a short to medium-term savings strategy for money that you’ll need in the next one to five years, but that isn’t needed for unexpected expenses like paying off a large credit card bill. Goals like saving for a new home or preparing for a renovation project are perfect for CD laddering.

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2. Open Your CD Accounts

Look around at different financial institutions for who has the best CD rates in California once you’re ready to open your accounts. Credit unions typically offer better rates than banks, so do your homework before choosing where to invest. You should also ask about early withdrawal penalties just in case you need to pull some money from a CD account in an emergency.

Once you’re ready to open your CD accounts, transfer the money into each allocated account, sit back and relax until your first maturity date rolls around!

3. Reinvest at Your First Maturity Date

As your shortest-term CD is about to mature, you’ll receive a notification from your bank or credit union to inform you that the date is approaching. Be sure to check that the CD doesn’t automatically renew.

Instead, you’ll want to withdraw that cash at the expiration date and reinvest it into a new, higher interest CD with a longer term than your current longest-term CD. Since it’ll likely be a new five-year term (and your current five-year term CD will now only have four years left), you should look for an account with the highest interest rate possible. Invest that original amount into this new CD and you’ve added a new run to your savings ladder.

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4. Continue to Reinvest or Cash Out

Over the next four years, you can keep repeating this process as each of your original CDs matures. But if you find yourself in need of some money, you don’t have to reinvest it. There’s always the option to withdraw and keep your money once each CD ends.

Rethink Your Investment Strategy with CD Laddering

Lock in your high-interest rate today with a CD account at SkyOne. Our Share-Certificate options are ideal for laddering your savings or putting aside a fixed sum for a few years. Watch your savings grow when you contact our team today to open a new Certificate account at SkyOne. Or click here to view our Certificate page, open an account, or learn more.

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