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Building a CD Ladder (And a CD Ladder Alternative)

With interest rates as low as they are, I’ve been getting questions recently about using CDs (specifically, CD ladders) to try to squeeze a little bit more yield from savings.

When to Use (and How to Build) a CD Ladder

CD ladders are typically best used for sums of money that you want to keep fairly liquid, but that you don’t expect to spend at any specific date in the future. For example, if your emergency fund is $24,000, you could build a CD ladder with the following purchases:

  • $4,000 in a 6-month CD,
  • $4,000 in a 1-year CD,
  • $4,000 in an 18-month CD,
  • $4,000 in a 2-year CD,
  • $4,000 in a 30-month CD and
  • $4,000 in a 3-year CD.

Then, six months later (when the 3-year CD has become a 30-month CD, the 2-year CD has become an 18-month CD, and so on), you buy another 3-year CD. The benefits of building such a CD ladder are that:

  1. You’ll always have a part of the ladder that’s coming due relatively soon (thereby giving you some degree of liquidity), and
  2. After 2.5 years, the CD ladder will be comprised entirely of CDs that were purchased as higher-yielding 3-year CDs.

Implementation note: Depending on the offerings of your favorite bank, you might not be able to get a 30-month CD. In that case, you can simply buy the other 5 CDs, and after 6 months, buy both a 3-year CD and another 2-year CD, thereby completing your ladder. (This completes the ladder because the gap that was previously at 30 months has now, after 6 months, become a gap at 24 months, which you’ll fill with the purchase of a 2-year CD.)

When Not to Use a CD Ladder

If you’re saving for a specific expense at a specific date (or even a semi-specific date) in the future, it probably makes more sense to just buy CDs of the appropriate maturity, rather than building a CD ladder. For example, if you want to use CDs to save for a home downpayment roughly 4 years from now, you probably want to purchase 4-year CDs rather than building a CD ladder that extends to 4 years.

It’s often wise, however, to use “parallel CDs” for such purposes. That is, instead of buying a single 4-year CD, you would buy multiple (smaller) 4-year CDs. That way, if you end up needing to spend some of the money prior to maturity, you’ll only have to pay an early redemption fee on a portion of the money rather than paying the penalty on the whole sum.

Low-Penalty CDs as a CD Ladder Alternative

Sometimes, even in the case of an emergency fund, it can make sense to simply purchase longer-term CDs with low early redemption penalties rather than building an entire ladder. For example, Ally Bank currently offers 5-year CDs with an early redemption penalty of just 60 days worth of interest. With a penalty that low, it might make sense to put the entire emergency fund into 5-year CDs right away (thereby getting the higher yield that comes with the longer maturity) rather than building a ladder.

It would still probably be a good idea, however, to purchase parallel 5-year CDs to minimize any early redemption penalties. This is especially true with Ally Bank because, unlike some banks, Ally offers the same rate regardless of CD size.

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  1. You may not need to set-up multiple CDs when considering low penalty CDs. Check with the bank to see if they offer partial withdrawals, most do.

    We also have an early withdrawal penalty calculator on our site. This will show you what your effective net rate would be if you close a CD early at different time frames. It allows you to determine if a longer-term CD will pay better than its shorter-term cousin when the penalty is taken into account. :O)

  2. Mike
    Not sure on this for an emergency fund. If you have said emergency one day after investing all of your cash, it’s going to be locked up for up to 3 years. If the intention is to cover 6 months expenses with your emergency fund then this won’t work. That said I can se the value for cash you are prepared to lock up for longer terms.

  3. Chris,

    Thank you for sharing that information.

  4. Herbert,

    I had been assuming that there’s some degree of liquidity available prior to tapping the emergency fund (e.g., some cash in a checking account or a credit card that could be paid off with the proceeds from an early-terminated CD before any interest would accrue on the credit card).

    I agree that nobody should ever entirely eliminate their sources of liquid funds.

  5. I like the simple way you explain things….
    I’m just not a fan of tying up a lot of money long term with the interest rates this low. If you employed your strategy over the last few years, you would have had a lot of money locked up not making enough return even to cover inflation. If rates were a little higher this would be a lot more attractive.

  6. Adam Hathaway says

    While this sounds like a good idea is there any way that this can be automated? This sounds like an awful lot of work.

  7. Adam,

    Not that I’m aware of. (Unless of course you count bond funds, many of which are basically perpetually-renewing bond ladders.)

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