Many people prefer to keep a certain amount of cash in their investment portfolio, especially when investing for periods of 5 years or less. However, savings accounts do not always give the best return on investment for cash. Certificates of Deposit (CD) usually offer better interest rates than savings accounts because a CD guarantees the bank access to your money for a certain time period. This allows the banks to lend your money to other people and earn a profit.

The only problem with CDs is liquidity - you must leave the money in the CD until it matures, or you face an early withdrawal penalty. However, there are options to increase your access to your money. Building a CD ladder is a simple and effective method of investing your money at better interest rates while maintaining some access to the money.

How to build a CD ladder: Let’s use a 5 year ladder as an example. In year 1 you invest in 5 separate CDs, one each for lengths of 1, 2, 3, 4, and 5 years. At the end of each year, you reinvest the money into another 5 year CD (unless the money is needed for other purposes). Here is an example:

Year 1:
Rung 1: 1 year CD - 1 yr remains
Rung 2: 2 year CD - 2 yrs remain
Rung 3: 3 year CD - 3 yrs remain
Rung 4: 4 year CD - 4 yrs remain
Rung 5: 5 year CD - 5 yrs remain

Year 2:
Rung 1: 2 year CD - 1 yr remains
Rung 2: 3 year CD - 2 yrs remain
Rung 3: 4 year CD - 3 yrs remain
Rung 4: 5 year CD - 4 yrs remain
Rung 5: 5 year CD - 5 yrs remain

Year 3:
Rung 1: 3 year CD - 1 yr remains
Rung 2: 4 year CD - 2 yrs remain
Rung 3: 5 year CD - 3 yrs remain
Rung 4: 5 year CD - 4 yrs remain
Rung 5: 5 year CD - 5 yrs remain

Etc.

In a 5 year CD ladder, one-fifth of the total investment is available once each year. This gives the investor the option of rolling the CD over, or using the money if needed. It also helps smooth the investor’s return on investment over a long time period. If the rates are good (as they are now) it allows the investor to lock in favorable returns for a set amount of time, which savings accounts do not allow.

CD ladders do not have to be built on a 5 year pattern. Some people use CDs for their emergency funds and base it on a 12 month rolling schedule. This way, they know they will never be more than a few weeks away from access to at least some of their money.

CD ladders may not be the best investment for everyone, but if you have some cash in your savings account that you will probably not need for a set amount of time, then building a CD ladder may be a good way for you to lock in higher interest rates and earn more money than you would in a savings account.

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