5 Moves to Optimize Your CD Ladder

CD laddering is a good way to manage yield and liquidity needs. Here are five moves to optimize your CD ladder so you get the best CD rates.
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Interest rates have risen noticeably over the past year, creating a dilemma for CD shoppers:

Should you opt for the higher rate of a long-term CD or stick with short-term CDs so you can reinvest your money more frequently as rates rise?

Having the opportunity to reinvest your certificates of deposit sooner can help you capture the highest interest rates. But you don’t need to settle for the lower yields of short-term CDs just to give yourself that opportunity. There’s another way to ensure you can reinvest more frequently — set up a CD ladder.

What Is a CD ladder?

A CD ladder is a strategy that lets you earn a higher yield than you would with short-term CDs while creating more frequent liquidity than you would have with a long-term CD.

Rather than lock up all your money for a specified period of time in one certificate of deposit, you would own a series of CDs with different maturity dates instead. That way, you can benefit from high-yielding, long-term CDs while still having money become available at regular intervals. In its simplest form, for example, this would consist of spreading your money equally among 1-year, 2-year, 3-year, 4-year and 5-year CDs.

Which Banks Have the Best CD Rates?

Hundreds of banks offer CDs, and there’s fierce competition among them to offer the best rates. Use our MoneyRates CD rate-finder tool below to sort through the list to find a CD that fits your financial goals.

How a CD ladder works

What impact could this technique have on your investment strategy?

As of mid-April, 1-year CDs were yielding 0.66 percent, according to national averages compiled by the FDIC. At the same time, 5-year CDs were yielding 1.26 percent.

FDIC National CD-Rate Average – week of April 15, 2019:

Obviously, you could earn a higher yield by putting all your money in a 5-year CD — but suppose you had some financial needs in each of the next five years or you simply wanted to make sure you had money available at regular intervals for reinvestment in a rising rate environment. A CD ladder could give you the benefit of both: a higher yield than a 1-year CD and the flexibility of making some of your money available at 1-year intervals.

Given where rates were in the middle of April, if you had spread your money evenly among 1-year, 2-year, 3-year, 4-year and 5-year CDs, you would have had an average yield of 0.964 percent with one-fifth of your money becoming available at yearly intervals. Unless you have a greater near-term need for your money than that, this is more profitable than simply owning a 1-year CD at 0.66 percent. The table and chart below compare the results of the three different strategies:

Comparing CD Growth Strategies

Example: Suppose you have $50,000 to invest in a CD for 5 years – but you also want the opportunity to capture higher interest rates during that period. Here is a comparison of what you could earn in five years using three different strategies:

  1. One 5-year CD for $50,000
  2. A CD ladder – Five 1-year CDs for $10,000 each
  3. Five 1-year CDs for $50,000 each

(Using FDIC national CD rate averages for the week of April 15, 2019.)

Term Opening Balance Year 1 Year 2 Year 3 Year 4 Year 5
One 5-year CD 1.26% $50,000 $50,630.00 $51,267.94 $51,913.92 $52,568.04 $53,230.39
CD Ladder $50,000 $50,482.00 $50,968.87 $51,460.64 $51,957.36 $52,459.09
Five 1-year CDs0.66% $50,000 $50,330.00 $50,662.18 $50,996.55 $51,333.13 $51,671.93

chart

There is no rule that says all the money in a CD ladder has to be distributed evenly – so you can weight your investments in different CD lengths according to when your needs are planned to arise and what the prevailing rate environment is.

5 ways to optimize your CD ladder investments

If you want to provide opportunities to capture higher interest rates or simply access your money occasionally, a CD ladder can help you there. But here are five tips that can help you optimize your CD ladder even further, especially in an environment where interest rates are rising.

1. Plan your CD ladder for the long haul

Rather than a CD ladder consisting of a 1-year, a 2-year, a 3-year, a 4-year and a 5-year CD, the ideal structure would be to own a series of 5-year CDs each bought one year after the other. That way you would still have CDs becoming liquid at yearly intervals to meet your immediate needs or be available for reinvestment, but each of those CDs would earn a higher, long-term yield.

You could accomplish this by buying a 5-year CD now, and then a new 5-year CD one year from now and each year after that. This takes longer than buying a mix of short-term and long-term CDs right away, but it could be more rewarding.

2. Employ the leapfrog method

If you want to set up your CD ladder right away, you have no choice but to buy a mix of short-term and long-term CDs. However, as the short-term CDs mature, replace them with long-term CDs rather than new short-term CDs.

All the other CDs on your ladder will have moved one year closer to maturity anyway; so by having proceeds from your maturing short-term CDs leapfrog in length over your other CDs to be reinvested into new long-term CDs, eventually you’ll get to that ideal structure of having a series of long-term CDs maturing at regular intervals.

3. Look for sweet spots in yields

Certificates of deposit reward you with higher yields for longer commitments, but those rewards are not always spread regularly as you move out toward longer CDs. This makes some CD lengths relatively more attractive than others.

Currently, the average 5-year CD yields 60 basis points more than the average 1-year CD. This 60-basis-point added reward for the four-year difference in length implies that you get rewarded 15 basis points for each extra year. However, the smallest reward is only 10 basis points in difference between a 4-year and a 3-year CD yield, while the 18-basis-point reward for moving from a 4-year to a 5-year CD is unusually big. This implies that you might want to weight 4-year CDs less heavily than the other investments in your CD ladder.

4. Do some comparison-shopping

Understand that CD rates vary widely from bank to bank. While the average 5-year CD rate is just 1.26 percent, MoneyRates’s CD rate-finder tool features several 5-year CDs yielding in excess of 3.0 percent. Rising interest rates over the past year have widened the differences between rates at different banks.

Shop around, and look at online banks to expand on your local choices. Nothing says that all the components of your CD ladder have to be at the same bank. In fact, spreading your ladder among different banks to get higher rates or better terms might also help you stay under the $250,000 FDIC insurance limit.

5. Weigh rates against flexibility

While your primary focus should be on rates, also look at early withdrawal penalties when shopping for CDs. Finding high-yielding CDs with relatively mild penalties would give you a little extra flexibility which may come in handy in a rising rate environment.

Rising rates have improved conditions for CD shoppers, and a well-constructed CD ladder can help you get the most out of this environment.

Frequently Asked Questions

Q: If I lock into a long-term CD and interest rates rise, how do I know at what point it’s worth “breaking” the CD – paying the penalty to get out earlier so I can get a new CD at the higher interest rate?

A: Most CDs do carry a penalty for early termination. So when is it worth paying that penalty so you can roll over into a CD at a higher interest rate? The time to start thinking about it is when the extra interest you could earn on a new CD exceeds the penalty you would pay. Remember, this is a function of both the incremental interest rate on a new CD and the time remaining on your old CD, compared to the penalty on the old CD.

When it would be worth more to switch than to stay in your current CD, you should be thinking about early termination, but that’s not necessarily the time to act. You’ll want to get a sense of what kind of momentum seems to be behind CD rates. If they are rising rapidly, you might want to hold off to see if you could do even better in a month or two. Also, there is the value of your time. You won’t want to switch for every minor incremental edge you could get with a new CD, but it is worth doing when those differences become significant. Translating those differences from theoretical interest rates to projected dollars should help you put this decision into perspective.

Of course, this is a reminder of the fact that there is more to choosing a CD than just finding the best CD rates. Seeking to minimize the termination penalty is also an important consideration. After all, a shift in the interest rate environment could easily leave today’s best CD rates far behind.

Q: I have a 3-year CD due to mature in nine months. Its APY is just 0.13%. I have an opportunity to invest in a 17-month CD at an APY of 0.325%. I am assuming the penalty for early withdrawal on the current CD is six months’ worth of interest. Would it be a smart move to break into that CD and invest the proceeds in the 17-month CD instead?

Here’s how the early-withdrawal-penalty math works out under the scenario you describe:

  • Your current CD would yield about 0.0975% in interest over the next nine months.
  • The 17-month CD would yield about 0.2437% in interest over those nine months.
  • That means the new CD would yield 0.1462% more than the existing one over the next nine months.
  • A penalty of six months’ worth of interest on the existing CD would amount to 0.065%.
  • Since the new CD would provide more additional interest than the amount of the penalty you face, you would come out ahead by switching.

The one uncertainty about all of the above is that you say you are assuming that the penalty is six months’ worth of interest. Check on that before making a move. You might find yourself happily surprised — some CD penalties diminish as the maturity date approaches.

Shop for the best CD rates

While eating the early withdrawal penalty and switching to a 17-month CD at 0.325 APY sounds like it could be a good move, it probably isn’t the best move you could make.

While 17-months is a bit of an odd time period (banks do that occasionally as a promotion), a quick look at the MoneyRates CD rates page would find you several 18-month CDs yielding well over 2 percent. In other words, switching to one of the best CD rates available could earn you a lot more interest than what you have in mind.

Consider a CD ladder

Finally, think about whether a 17-month CD meets your needs. Can you afford to tie up the money for that long? Could you commit the money for an even longer period to earn a higher rate?

With rates rising, it might be a good idea to consider a CD ladder. By splitting the proceeds from your current CD into two or more CDs with staggered maturity dates, you could earn higher yields and still have money that becomes available for reinvestment at regular intervals.

That way, if CD rates continue to rise, you would have periodic opportunities to reinvest at higher yields without facing your current dilemma of whether or not to pay an early withdrawal penalty.

Richard Barrington, a Senior Financial Analyst at MoneyRates, brings over three decades of financial services expertise to the table. His insightful analyses and commentary have made him a sought-after voice in media, with appearances on Fox Business News, NPR, and quotes in major publications like The Wall Street Journal and The New York Times. His proficiency is further solidified by the prestigious Chartered Financial Analyst (CFA) designation, highlighting Richard’s depth of knowledge and commitment to financial excellence.