What is a CD Ladder?
A CD ladder is a method of purchasing certificates of deposit in such a way as to earn a higher interest rate while still having access to some of your certificate of deposit cash at a tolerable frequency.
More specifically, a CD ladder is the process of splitting a lump sum into numerous CDs, each with a longer maturity than the previous. This laddering allows you to earn higher rates of longer terms while still having maturities coming due on a short-term basis.
How Does a CD Ladder Work?
To illustrate how a CD ladder works, suppose you had $10,000 available for CD investing, but you're afraid to tie up your cash for any longer than 6-months. Therefore, you elect to purchase a $10,000 6-month certificate of deposit that pays you, say 1% interest.
The downside of that certificate of deposit investment is that if you purchased a 36-month certificate of deposit, you might have been able to earn 2.25% on your money -- thereby more than doubling your interest earnings.
With CD laddering, you can achieve a happy medium.
Using the above example, instead of investing $10,000 in a single 6-month certificate of deposit earning only 1%, you would split up the $10,000 into 6 CDs -- each with a term that is 6-months longer than the others.
In that case, you would put 1/6th into a 6-month CD, 1/6th into a 12-month CD, 1/6th into an 18-month CD, and so on.
Next, as each of your original CDs reaches maturity, you roll them over into a certificate of deposit having the longest term -- which in our example is 36 months.
The beauty of CD laddering is that eventually all of your money will be earning the higher interest rate (2.25% in our example), but you will still have access to 1/6th of your cash every six months. Cool!
When Should You Consider CD Laddering?
CD laddering, or CD investing in general, should only be considered if you have a fully funded emergency fund (3-6 months of your take-home pay, preferably stored in a money market account), and you have paid off all of your high-interest debt.
If you don't have a fully funded emergency fund, then you shouldn't be putting your savings into an account where emergency withdrawals will wipe out your interest earnings -- or worse, incur early withdrawal penalties.
Or, if you have outstanding high interest debt, then it doesn't make any sense to earn 1-3% in a certificate of deposit when you can earn 18% by using the cash to invest in your debt.