What Is a CD Ladder?

What Is A CD Ladder?

There are many different ways to grow your money. For some, a certificate of deposit (CD) is an attractive savings option, offering a guaranteed interest rate. However, one drawback associated with CDs is the lack of liquidity. Depending on the CD type, you may not be able to withdraw funds before the maturity date.

One strategy that may help overcome those concerns is trying a CD ladder approach. Investing in CDs with varying maturities, allows you to earn guaranteed interest rates while maintaining greater liquidity and adding flexibility. 

It allows you to put some savings into a CD and earn a guaranteed interest rate while also allowing for greater flexibility. Here's what you need to know about this strategy.

What Is A Certificate Of Deposit?

A certificate of deposit is a savings product that offers a pre-determined fixed interest rate over a set period, called a maturity date. The term of a CD may run from a few days to upwards of ten years, depending on the financial institution.

Many financial institutions offer CDs, and the opening process is relatively straightforward. Simply choose your preferred institution, deposit your funds into a CD, and wait for it to reach its maturity date. Once the CD matures, you can withdraw both the initial deposit and the accrued interest.

CDs typically have limited liquidity and flexibility. Withdrawing funds from a CD before the maturity date could result in penalties that may offset any interest earned. CDs may not be ideal if you might need to access the funds before the maturity date. In this case, a high-yield savings account may offer a more suitable solution.

Understanding A CD Ladder Strategy

If you like the idea of using CDs as part of a savings strategy but aren't sure about being unable to access the money, CD laddering may be something to explore.

What is a CD ladder? It's a strategy of purchasing multiple CDs but staggering maturity dates to allow for occasional liquidity as each one matures^[1]. Depending on your needs and strategy, you may be able to distribute the funds evenly or use different amounts for each CD.

This approach allows you to take advantage of attractive interest rates, which may make a significant difference over time. You may earn more interest from a CD ladder than purchasing one shorter-term CD and rolling it over. Often, but not always, the longer CD, the higher the interest rate. However, you may not want those funds locked up for an extended period.

A CD ladder offers potentially higher interest rates while providing flexibility and liquidity from a consistent maturity schedule.

Example Of How To Build A CD Ladder

Imagine you have $5,000 to put into a CD. Rather than tying up the entire amount in a single 5-year CD, consider spreading the funds over several CDs.

• $1,000 in a one-year CD
• $1,000 in a two-year CD
• $1,000 in a three-year CD
• $1,000 in a four-year CD
• $1,000 in a five-year CD

With this approach, you're growing savings over five years rather than keeping the $5,000 locked away where you can't touch it. Over time, you'll have access to the funds on a regular schedule. In this example, you only need to wait one year for the first maturity date while the rest of the CDs continue to earn interest.

CD laddering can continue for as long as it fits your financial needs.

Once a CD matures, you can either renew the CD at the interest rate available at that time, or you can withdraw the funds and put the money back into your savings or use it to help fund a short-term spending goal.

The Pros and Cons Of CD Laddering

As with any savings plan, there are benefits and drawbacks, so it's important to understand each before determining your best path forward.

What Are The Advantages Of A CD Ladder?

• More liquidity: Laddering offers more liquidity compared to a single CD. While each CD has a fixed term, laddering ensures that a portion of your savings are available regularly as each matures.
• Varied interest rates: Spreading savings across multiple CDs with different maturity dates means possibly taking advantage of varying interest rates. You may earn more interest with laddering compared to what you would with just one CD. However, it’s also possible that CD rates may drop over time, so this is also a potential disadvantage.
• Lower risk: CDs are generally considered low-risk, so adding these to your savings strategy can help reduce overall risk.
• Flexibility: CD ladders are often customizable to suit your financial goals and needs. You can choose the number of CDs, the amounts, and the maturities that align with your financial plans.

What Are The Disadvantages Of A CD Ladder

• Lower returns: Compared to other savings products, CDs may offer lower returns.
• Opportunity cost: You may miss out on other potential higher returns during the CD ladder's duration. For example, if interest rates go up, you may not benefit from the higher rates.
• Complexity: Managing a CD ladder can require organization as you need to keep track of multiple CDs with different maturity dates.
• Limited liquidity: CD ladders provide some liquidity as CDs mature. However, the funds remain locked away until each maturity date.

Overall, using a CD ladder approach is one way to take advantage of some of the benefits of CDs while limiting many drawbacks. However, it's important to weigh the drawbacks and consider whether they align with your financial goals.

Are There Other Versions Of CD Laddering?

Since there are so many varieties of deposit certificates, you can consider different laddering strategies to find the best approach for you. Here are a few common examples to consider.

Short-Term or Mini CD Laddering

With this approach, you use CDs with short maturity dates, such as a few months^[2]. This may help take advantage of short-term interest rate fluctuations and give even quicker access to your money.

For example, if you have $5,000 and a shorter time frame because of liquidity concerns, you could do the following:

• $1,250 in a three-month CD
• $1,250 in a six-month CD
• $1,250 in a nine-month CD
• $1,250 in a one-year CD

While this strategy offers greater access to funds, short-term CDs typically have lower interest rates compared to longer-term CDs. Consider the potential lower earnings potential as you weigh the options. 

The Barbell or Uneven Splits Strategy

The barbell strategy involves allocating a larger portion of your funds to CDs that mature both earliest and latest while distributing the remaining funds more evenly across CDs with intermediate maturity dates^[3]. This strategy, known as uneven splits, allocates funds strategically rather than evenly. 

By focusing on both short-term accessibility and long-term growth, the barbell approach balances the potential for higher interest returns with the practical benefit of increased liquidity. This method is particularly effective for those who wish to optimize their returns while maintaining some level of access to their funds.

For example, with $5,000 and a six-year timeframe, you may allocate CDs as follows:

• $1,500 in a one-year CD
• $500 in a two-year CD
• $500 in a three-year CD
• $500 in a four-year CD
• $500 in a five-year CD
• $1,500 in a six-year CD

With this strategy, you may need to be more savvy about what's happening in the market, economy, and Federal Reserve monetary policy to lock in the best rates. For many, spreading funds evenly across CDs can be a simpler strategy that's easier to follow.

Consider Economic Projections and Current Market Conditions

When building or adjusting a CD ladder, it's important to consider economic projections and current market conditions. Economic indicators, such as unemployment rates and consumer spending, provide a snapshot of the overall health of the economy and may signal changes in interest rates that can directly impact CD returns^[4]. For example, strong economic growth might lead to higher interest rates, while an economic slowdown could see rates decline. 

Knowing whether interest rates are rising, falling, or holding steady may help you choose the timing and maturity to optimize returns for your CDs. Keeping up with financial news can provide real-time insights into changes in current market conditions that might affect interest rates and, consequently, your CD strategy.

Adjusting CD Ladder Strategies Based on Interest Rate Changes

Interest rates can significantly impact the effectiveness of a CD ladder. Adapting your strategy to align with these changes may help you maximize returns while maintaining liquidity. 

Rising Interest Rates: Focus on Shorter-Term CDs

In a rising-rate environment, shorter-term CDs can be more advantageous. As each CD matures, you can reinvest the funds into new CDs at higher rates, compounding earnings. This approach keeps investments flexible, enabling you to respond quickly to rate increases and optimize savings growth.

Falling Interest Rates: Opt for Longer-Term CDs

When interest rates are expected to decline, it's often beneficial to secure longer-term CDs at the current higher rates. Locking in longer maturities before rates drop protects the investment from the downward trend and provides higher interest income over an extended period. This strategy may stabilize returns and provide a steady income stream despite falling rates.

Choose the Best Savings Strategy for Your Needs

CD laddering enhances the predictability of returns and adds liquidity to your savings strategy, making funds accessible when needed. This added flexibility makes CD laddering an appealing option for many, although it may not align perfectly with everyone’s financial goals and liquidity requirements.

Ultimately, it's important to choose a strategy that aligns with your specific financial needs and objectives. Before committing to a CD laddering strategy, review your financial situation and goals to determine whether it's appropriate for your long-term cash flow needs and overall savings strategy.

Learn more about PNC's certificate of deposits to see if a CD ladder works for your financial goals.