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What Is a CD Ladder and When Is It a Good Idea?

One of the silver linings of historic inflation and all the Fed interest rate hikes is that for the first time in years, you can make legitimate money on your cash.

That includes traditional savings accounts, U.S. treasuries, money markets and Certificates of Deposit (CDs). Picking between the best and worst options on the market, and picking the choice that’s appropriate for your financial situation, now involves real stakes.

What about CD laddering? Is that a favorable strategy to squeeze the most out of your savings? That’s what a listener of the Clark Howard Podcast recently asked.

What Is a CD Ladder?

If you don’t need your cash in the near term, you can lock it into a CD and get a better interest rate than you would in a savings account.

However, there are at least two risks with a CD.

First, if you need to use the money for something before the end of the term you agreed to for the CD, you’ll get penalized. Second, if you lock into an interest rate for a prolonged period — and then interest rates continue to increase — you could be stuck earning less interest than you would on the open market.

The first potential drawback of a CD is especially significant. Five-year CDs allow you to earn superior rates compared to one-year CDs, for example. But then your money is locked up and not liquid for an extended time period, barring penalties for early withdrawal.

That’s where the idea of a CD ladder comes in. A listener asked Clark about the idea on the Dec. 7 podcast episode.

Asked Shannon in Texas: “Can you please explain CD ladder investing and when it would be a good idea for someone?”

Let’s start by outlining the basic idea of a CD ladder.

“The concept of laddering in the simplest form is, you take your pile of money you can put into CDs and you divide it into five piles,” Clark says.

“Twenty percent goes into a 1-year, 2-year, 3-year, 4-year and 5-year CD. When the [money from the] first-year CD becomes available after 12 months, you then put it in a 5-year CD.

“That means 20% of your money is always one year or less away from being available to you. But by historical measures, you’ll be earning the highest rates [with the 5-year CDs].”

Why a CD Ladder Isn’t the Best Strategy Right Now

A CD ladder works better when interest rates rise than when interest rates fall.

When interest rates rise, you can take the money from the shorter-term CDs that are maturing and put it back into longer-term CDs at higher APYs.

However, the inverse is also true. If rates are declining, you could be putting your money back into CDs with lower long-term interest.

“The laddering concept was very useful to people as interest rates were rising,” Clark says. “It’s not as useful once interest rates reach pretty much where they’re going to be. And not as helpful when rates start going down. Unless you need available money.”

Longer-term interest rates are already starting to decline, Clark says. Inflation has started to trickle down in steady chunks every month. Clark is predicting that interest rates are going to top out in the near future.

Charles Schwab and Fidelity Investments, Clark’s two favorite institutions to buy CDs, are paying nearly 5% on certain CD terms right now.

“I think there’s an opportunity to lock in money that you can afford to lock in, into longer-term CDs,” Clark says. “Money you can afford to tie up, we’re in a cycle where putting as much as you can in five-year CDs will be more to your advantage than being in shorter terms or in savings accounts.”

Final Thoughts

If you have cash that you don’t need immediately, you can consider putting it into a CD.

CDs often earn higher interest rates than savings accounts.

However, with interest rates potentially leveling off, it may be a better idea to pile as much of that money into a 5-year CD rather than constructing a CD ladder.

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