CD Laddering is a type of investment strategy that is used when CD rates are rising, usually when the economy is strong and the Federal Reserve is raising their key benchmark interest rate, the federal funds rate. The federal funds rate is increased by the Fed to prevent the economy from over heating and fanning inflation.
CD rates can also rise when economic growth is slower, these periods are known as “stagflation” growth is slow but interest rates rise. We went through a period of stagflation during the 1970’s during the oil embargo when inflation was high because of rapidly rising oil prices.
Bank CD rates are tied to the federal funds rate, so when the rate is increased, bank rates also move higher. When the rate is lowered, banks follow by lowering the rates they offer on certificates of deposits and other types of deposit accounts. For the past 5 years CD rates at banks have been near record lows though rates will finally be moving higher next year. Which makes this a good time to review what a CD ladder is and how you can set one up.
When you search for CD rates you’ll see the longer the certificate of deposit term, the higher the CD rate or CD interest yield usually is, that is unless the yield curve is inverted. When you lock into a long term certificate of deposit you also run the risk of losing out on earning more interest if CD rates are increasing. Which is why it is important to only setup a CD ladder when CD rates are increasing.
How Certificate of Deposit Laddering Works
The strategy used in a certificate of deposit ladder is to evenly spread your investment in CD accounts over a period of several years. The end result when setting up a CD ladder is all your money will be deposited in longer term CD accounts earning higher CD rates.
You might be thinking, why not just invest all your money in a long term CD account? You can but when CD rates are increasing and you open a long term CD account today you miss out on higher rates. Another benefit to laddering is you’ll have access to your money sooner than you would if you invested all of your money in one long term CD account.
The following example will show you how a CD ladder is setup and how you can benefit from setting one up.
Example of a CD Laddering Strategy
In this example we will use a three year CD ladder strategy with $30,000 to deposit. The CD investor deposits $10,000 in a 3 year CD, $10,000 in a 2 year CD and $10,000 in a 1 year CD.
After the first year, the 1 year $10,000 CD matures, the CD investor then invests the money into another 3 year CD. After the second year, the 2 year $10,000 CD matures, the CD investor invests in yet another 3 year CD. After 3 years all the money is in 3 year CD accounts that are locked in earning better CD rates then they could with a 1 year CD account.
CD Ladder Calculator
There are tools available to you to help you with deciding which type of CD ladder to setup. The example above is just one way of setting up a ladder. You can use all types of CD terms and deposit amounts to setup your ladder. One of the most useful tools to help you setup a ladder is a CD ladder calculator.
We offer a free CD ladder calculator here: CD Ladder Calculator
Our calculator gives you the ability to enter up to 5 CDs in a ladder. You can also set how frequently the CD accounts mature and enter CD rates for each CD term.
You can also view a report of your CD ladder that compares how much interest you earn with a ladder to just opening a single CD account and rowing it over year after year.
Over the next several years CD rates will be increasing so now is a good time to start thinking about setting up a CD ladder.