If you're like many young people just starting to save, you’ve probably heard of a certificate of deposit (CD). It sounds like a smart idea for building savings, but the concept of a CD ladder might have you scratching your head. Don't worry, you're not alone! Let's break it down and help you understand how a CD ladder works and whether it's a good fit for you.
A CD ladder is a smart way to build savings while earning a higher interest rate. It’s a strategy where you open multiple CDs with different maturity dates. In simpler terms, you split your savings across several CDs with varying terms (like 1-year, 2-year, 3-year, etc.) rather than putting it all into one CD.
The cool part? As each CD matures, you can either reinvest the money into a new CD or use it for something else. This gives you regular access to some of your money without the risk of locking it up for too long. So, instead of having all your money tied up for a long period, a CD ladder gives you flexibility.
Meet Jake, a recent college graduate. He just got his first tax refund check, and let’s just say, it’s burning a hole in his pocket! Jake still lives at home, so his expenses are low, and he’s been thinking about putting some of this money away for the future.
But Jake isn’t just interested in sticking his money in a savings account. He wants to see it grow, and he wants to do it the smart way. Plus, he needs to be able to get at least some of it in the next year.
That’s when he hears about the idea of a CD ladder. By spreading his money across a few different CDs (say a 1-year, 2-year, and 3-year CD), Jake can earn higher interest rates than a regular savings account, but he doesn’t have to wait five years to access his money. After a year, the first CD will mature, and he can reinvest it into a new one or use it for something else. This gives Jake the best of both worlds: his money grows at higher rates, but he still has access to it when needed.
Higher Interest Rates: Unlike a regular savings account, which typically offers low interest, CDs generally offer higher rates, meaning you earn more on your money. A high-yield CD can significantly boost your savings compared to a basic savings account.
Flexibility & Accessibility: With a CD ladder, you’re not locked into long terms. If you need access to some money, it’s available when one of your CDs matures. You can always choose to reinvest it or use it for something else.
Lower Risk: A CD ladder is low-risk. As long as you’re working with an FDIC-insured bank or an NCUA-insured credit union, your money is protected up to $250,000. Plus, you don’t have to worry about the ups and downs of the stock market.
It’s simple to set up a CD ladder. Here’s how Jake could do it with $2,000:
Open the CDs: He decides to open 5 CDs with terms of 1 year, 2 years, 3 years, 4 years, and 5 years. He divides his $2,000 equally: $400 in each.
Wait for the CDs to Mature: Each year, one of Jake’s CDs will mature. When it does, he can choose to:
Reinvest it in a new CD for another 5-year term.
Use the money for something else (maybe a down payment on his first car).
This ladder will continue to grow as long as Jake wants it to, giving him access to funds each year, while still earning higher interest than a savings account.
With a CD ladder, you’ll have a mix of short-term and long-term CDs, which means you’ll have a good balance between higher interest rates and frequent access to funds.
Short-Term CDs (like 1-year or 2-year) usually offer lower interest rates than long-term CDs, but you can access the money sooner.
Long-Term CDs (like 4 or 5 years) often offer higher interest rates, but your money is tied up longer.
When the rates on your short-term CDs rise, you can reinvest them into a higher-rate CD. If the rates go down, your long-term CDs will still have a higher interest rate compared to newly issued CDs.
Yes, a CD ladder is a safe investment, especially for someone like Jake, who’s just getting started with saving. Since CDs are NCUA-insured, they provide peace of mind knowing that your money is protected.
However, if you’re looking for something that gives you quick access to your money without penalties, a high-yield savings account might be a better fit. With a CD, early withdrawals often come with a penalty.
Good question! If you need to pull money out of a CD before it matures, you might face an early withdrawal penalty. This penalty can eat into the interest you’ve earned, and sometimes even your principal. That’s why it’s important to only invest in CDs you’re sure you won’t need to access early. If flexibility is more important to you, an online savings account could be a better option.
You don’t need a ton of money to start a CD ladder. Jake, for example, started with $5,000, but you could start with as little as $500 or $1,000. The more you invest, the more your savings will grow, but the flexibility to start small is one of the great things about a CD ladder.
While CD ladders are a low-risk strategy, they do come with a few downsides:
Access to Money: Your money is tied up for a period, and early withdrawals can result in penalties.
Inflation Risk: If inflation rises faster than your interest rate, the value of your money could be eroded.
Complexity: Keeping track of multiple CDs with different terms and maturity dates might be a little complicated, especially if you miss a renewal date.
But for someone like Jake, who wants to grow his savings but still needs access to some of it soon, a CD ladder is a great way to get started without taking on too much risk.
At First Alliance Credit Union, we believe in showing up for our members, listening to their stories, and providing possibilities for the future. Our vision is to create a financial oasis means we offer the tools and resources you need to make smart decisions with your money, like building a CD ladder.
Whether you're just starting out, like Jake, or you're looking for a fresh start, we’re here to guide you through your financial journey with passion, persistence, and presence.