How to Use CDs to Make Passive Income

Income streams that don't require regular active involvement are typically dubbed "passive income." CDs (certificates of deposit) are an excellent example of passive income since you don't need to touch them at all once they're established.

Indeed, if you set up your CDs right, you can enjoy a stable, consistent, relatively low-risk source of income that requires only minutes of your time once or twice a year.

The key? Laddering.

Ladder your CDs for consistent earnings

Good passive income sources are long-term and consistent. The best way to get this with CDs is to build a CD ladder. This is when you have a variety of CDs that mature at different times -- ideally, at regular intervals -- to give you reliable income for years to come.

Suppose you have $10,000 to invest. A good laddering strategy might look like this:

• $2,000 into a 12-month CD
• $2,000 into a 2-year CD
• $2,000 into a 3-year CD
• $2,000 into a 4-year CD
• $2,000 into a 5-year CD

When the first short-term CD matures, you can roll it over into a new 5-year CD. Do this each year going forward. You'll wind up with a CD that matures each year, not only freeing up cash if you need it but also letting you benefit from compound interest.

Why use long-term CDs?

You may wonder here why I don't suggest investing the full $10,000 into a single 1-year CD, then just rolling that over as you go. This is definitely a viable strategy, especially right now when CD rates are so high.

However, if your goal is passive income, long-term CDs require way less maintenance. More importantly, though, long-term CDs lock in interest rates much longer. So if rates drop over the next few years -- which is predicted to happen, though it's hard to say when -- your longer-term CDs will keep on truckin' for at least a few years before you have to deal with the lower rates.

Rollover maturing CDs as rates/needs warrant

As each CD matures, you'll have the option to withdraw your money and do something else with it or to reinvest it into a new CD. Many CDs will roll over automatically, offering a brief grace period after maturity to withdraw your funds before they're rolled into a new CD.

If you're using your CDs for passive income, you may choose to withdraw your interest earnings while reinvesting the original principal into a new CD. If you don't need the income at that time, you could reinvest it all and let it continue to grow. Or, if you need the funds, you can simply withdraw it all.

When rates are high, like now, CD earnings can definitely make up a larger portion of your passive income. If rates go down, you may want to consider if there are other, more profitable, options.

Part of a complete portfolio

CDs can be a great part of a balanced, diverse portfolio. They are simple to set up, require minimal maintenance, and can offer consistent, low-risk income. You'll need fairly substantial investments to actually live off of that income, but it's definitely possible if you build up your savings and take advantage of high-yield CDs.