Laddering a Certificate of Deposit (CD), an Investment Strategy to Earn More Interest

Laddering a certificate of deposit 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 fed increases the rate to prevent the economy from over heating and inflation rising.

CD rates can also rise when economic growth is slower. These periods are known as “stagflation.” Growth is slow during these times but interest rates rise. We went through a period of stagflation during the 1970’s during the oil embargo. Inflation was high because of rapidly rising oil prices but economic growth slowed.

Bank CD rates mirror the direction of the federal funds rate, so when the rate is increased, bank rates also move higher. Likewise, when the rate is lowered, banks lower their deposit rates.

When you search for CD rates you’ll see the longer term certificates of deposit have higher rates. 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 Laddering a Certificate of Deposit Works

The strategy in laddering a certificate of deposit is to evenly spread your money in separate accounts over a period of several years. 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. Every year a longer term CD account matures instead of having all of your money in one long term CD account.

The following example will show you how a CD ladder is setup.

Example – Laddering a Certificate of Deposit Strategy

In this example we will use a three year CD ladder strategy with $30,000 to deposit. The investor deposits money into 3 CD accounts.

• 1 Year CD $10,000 investment
• 2 Year CD $10,000 investment
• 3 Year CD $10,000 investment

When 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 have passed all the money is in 3 year CD accounts earning higher CD rates.

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.

In the screen shot to the right, one laddering strategy shows investing $100,000 in 5 CD accounts ranging from 1 year to 5 years initially will earn $8,230.32 more in interest.

A CD calculator usually 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 will earn with a ladder.

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.