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How to Create the Ultimate Certificate of Deposit (CD) Ladder

This article was written by in Banking. 13 comments.


If you are disappointed with the low interest yields offered by even the highest-yield savings and money market accounts, but you don’t want to tie your short-term cash in a riskier investment, consider certificates of deposit (CDs). CDs, however, generally carry penalties if you withdraw your cash before they mature. In other words, you invest in a CD designated with a length of time that represents when you would like your money, plus interest, back. But if you need to liquidate the CD, a bank may take away some or all of the interest that has accrued since the time of the deposit. Be sure to be aware of the best CD rates so you’re prepared for how much you can earn.

A certificate of deposit is considered a “deposit account” just like a savings account or money market account. You are allowed to earn interest, and if the bank enrolls in the program, your cash will be protected by the FDIC up to the limits allowed by law.

There is a way to structure your certificates of deposit in a form that reduces the risk of losing a large portion of your interest, and it is called a CD ladder. At staggered intervals, you buy CDs with staggered maturity dates until you only need to buy CDs with the longest maturity date. The result is every few months, a CD matures and you can roll the cash into a new CD or use the cash for your short-term expense needs.

The process consists of two phases. For this example, we’ll use the latest rates from Ally Bank which does not have a minimum balance requirement.

Setting up the ladder

These are the CD products and interest rates we will be dealing with. These are example rates, so check with your bank to determine the interest you’ll earn. APYs are as of October 17, 2014.

Duration APY
3 Month 0.30%
6 Month 0.60%
9 Month 0.65%
12 Month 1.00%
2 Year 1.20%
3 Year 1.20%
4 Year 1.30%
5 Year 2.00%

We can use this combination of maturities to create a ladder that provides us with a roll-over, or a chance to withdraw part of the cash, every three months. During Phase 1, this will require a combination, but by Phase 2, all CDs will be of the 5-year maturity, which usually offers the highest interest rates. Remember that five years is as long as you want to go; any money that you won’t need for more than five years can stand to be in a slightly riskier investment.

Assume that we have $10,000 that we’d like to begin rolling into certificates of deposit. Since the longest we want to go is five years, we can split this evenly over time at $2,000 per year. Our shortest maturity is three months, so we can tackle this in terms of $500 a quarter.

In the first phase, start on day zero by buying CDs in the following pattern:

  • $500 in the 3 month CD
  • $500 in the 6 month CD
  • $500 in the 9 month CD
  • $2,000 in the 12 month CD
  • $2,000 in the 2 year CD
  • $2,000 in the 3 year CD
  • $2,000 in the 4 year CD
  • $500 in the 5 year CD

At the end of the each of the first three quarters, withdraw each quarter’s $500 plus interest and use the funds to buy new 5 year CDs. For the sake of the example, we’ll withdraw the interest and place it in another bank account to use as income. To make more of your money, “reinvest” your interest each quarter.

Watch out for automatic renewal. At Ally Bank, CDs are automatically renewed for the same duration when they mature. During this stage, you will need to be proactive to withdraw the funds at maturity and use them to buy the next appropriate CD.

After one year of doing the above, this is what we have:

  • $2,000 maturing today (original 12 month CD)
  • $2,000 maturing in one year (original 2 year CD)
  • $2,000 maturing in two years
  • $2,000 maturing in three years
  • $500 maturing in four years
  • $500 maturing in four years, three months
  • $500 maturing in four years, six months
  • $500 maturing in four years, nine months

With the $2,000 maturing today, buy:

  • $500 in the 3 month CD
  • $500 in the 6 month CD
  • $500 in the 9 month CD
  • $500 in the 5 year CD

Do the same with the $2,000 that matures each year until you have 20 CDs, each maturing every quarter for the next five years. Once this process is complete, you can allow the automatic renewals to take effect except for when you need to withdraw your money.

Drawbacks of the CD ladder

You may notice that, as long as rates for long-term CDs remain higher than short-term CDs as they do most of the time, this method results in earning less than simply investing your entire $10,000 in a 5 year CD. But the CD ladder provides you some protection against losing interest if you need to withdraw your funds early. At Ally Bank, the penalty is not significant. This bank will charge you the amount of three months’ interest if you withdraw a CD with a maturity of 12 months or less or 6 months’ interest if you withdraw a CD with a maturity of longer than 12 months.

Another possibility to consider is that you might earn more interest in a high-yield savings account than you would in a short term CD. Ally Bank’s Online Savings Account earns 0.90% APY as of October 17, 2014, making it more attractive than the 3, 6, and 9 month CDs. When this is the case, use a specially designated savings account rather than the short term CDs.

We could have made this process easier by setting up a ladder that results in a turnover of $2,000 once a year rather than $5,000 every quarter. This method allows you to decrease the possibility of losing interest because you will always be able to access a portion of your investment within three months. In combination with a savings account, which is liquid at all times, you can earn consistently higher interest rates with less risk than using five-year CDs that mature only once a year.

Updated October 17, 2014 and originally published July 31, 2009. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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About the author

Luke Landes is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about Luke Landes and follow him on Twitter. View all articles by .

{ 13 comments… read them below or add one }

avatar KC

My only concern right now locking into a 5 yr CD rate is that at some point rates have to go higher. You could be stuck at year 3 in a 5 yr CD with a rate that is equivalent to what a 1 yr CD is paying out currently. I guess the simplest solution to this would be to stop at 1 year CDs until the field improves a little. It would also solve the problem of tying up too much money too soon.

But I am a big fan of CDs. I think of them as my conservative investing. I have a large emergency fund, but it currently only gets 2% in the bank. I also have investments (retirement and long term savings). But I need something in-between and CDs are a good place.

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avatar Matt

I’d agree with KC, I’ve been buying 1 yr CDs. Rates can’t get lower from here, and there are better opps in the TIP etf and/or I Bonds right now. I’ve done this with half my emergency fund, with the other half available to cover the interim.

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avatar Matt

I’d agree with KC, I’ve been buying 1 yr CDs. Rates can’t get lower from here, and there are better opps in the TIP etf and/or I Bonds right now. I’ve done this with half my emergency fund, with the other half available to cover the interim.

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avatar Matt

I'd agree with KC, I've been buying 1 yr CDs. Rates can't get lower from here, and there are better opps in the TIP etf and/or I Bonds right now. I've done this with half my emergency fund, with the other half available to cover the interim.

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avatar Matt

I'd agree with KC, I've been buying 1 yr CDs. Rates can't get lower from here, and there are better opps in the TIP etf and/or I Bonds right now. I've done this with half my emergency fund, with the other half available to cover the interim.

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avatar Bobka ♦13 (Newbie)

Thanks for the excellent advice. Ally Bank seems to be a good place to start looking for a long term CD with good rates and limited early withdrawal penalty, if required.

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avatar Ceecee ♦53 (Newbie)

As a really conservative investor, I’d like to create one of these. Thanks for the excellent information.

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avatar BobbyC

Currently Ally only applies a penalty of 60 days of interest on early withdrawal. Why wouldn’t you always want to get the 5 year CD at 2.4% even if you plan on taking the money out in 1 year. In this case, if you are 3 years into a 5 year CD and a compellingly higher rate is available you can withdraw the funds and open a new 5 year CD with only a 2 month penalty. If you invest $100,000 at 2.4% you’ll be earning around $200 a month. After 3 years you’ll have earned almost $7500 and it will cost you around $ 236 penalty to take all of the money out and fund a new CD or just because you need the cash. Most of the 5 year CDs I have researched have a 180 day penalty and worthy of more consideration.
With $100,000 in a 5 year CD at 2.4% after 1 year you’ll have earned around $2426 and it will cost you around $ 217 penalty so you’ll have an after penalty gain of $2209. If instead you invested in a 1 year CD at 1.24% you’ll have a gain of around $1247 at maturity. So I’ll take the penalty any time. Is my logic wrong? Somebody straighten me out if I am.

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avatar Bob C

I have thought like bobby c for some time now but I’m glad to see there is another who thinks the same way. bob c

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avatar MikeW

I’d take the penalty, too, like BobbyC said.
Just have to be extra careful on finding the right bank and fully knowing and understanding their requirements and penalty for early withdrawal.
If you really need the money right away / emergency, you won’t be so worried about what the penalty is.
However, if it’s a significant rise in rates, you’d have to compare the amount you’d lose via the penalty versus how much you might gain with the new rates, or at least how long it would take a new cd with higher rates to make up the difference. Too small of a rise in rates might not be enough to offset the penalty at all.

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avatar Anne & Matt

I am switching over to Ally and bought a few CDs. But, I think they’ve changed their early withdrawal fees:

“We will only charge a penalty if you make a withdrawal before the CD matures. For all CDs, the early withdrawal penalty equals 60 days’ interest. This penalty does not apply to No Penalty CDs.”

Looks good to me!

With that kind of no-big-deal penalty, I’m wondering if I could buy a few 5-year CDs. Maybe $500 a piece? If I have to get the money, it’s a smaller loss than if it were all in one (and I really don’t think I’ll need that money). Right now, I have some in a 12m and some in a 5y and I’m still deciding on what to do with the rest.

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avatar Joe

Psst…you forgot that Ally adds a 0.25% bonus on top of the current interest rate when you roll the CD over.. You can change the term if you want

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avatar Ben

Ally also offers bump-up CDs which they call “Raise Your Rate” with 2- and 4-year maturities. The 2-year allows you to bump your rate once, and the 4-year twice. You can build a ladder using just bump-up CDs, although the setup is a bit more complicated, but it will give you a hedge against interest rate risk.

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