One Unbeatable CD Strategy for a Rising-Rate Environment

Here's a strategy to consider if you're worried about getting the most out of your savings.

Certificate of deposit accounts, or CDs, pay better interest rates than savings accounts, all other factors being equal, but there are some major downsides. Specifically, CDs are time deposits, which means you are committing to leave your money in the account for a certain amount of time in exchange for the higher yield. And banks generally give higher APRs for long-term CDs than shorter-term CDs.

However, there's a strategy known as a CD ladder that could help solve the problem by taking advantage of the high yields of long-term CDs, but with significantly greater financial flexibility.

What is a CD ladder?

If you aren't familiar with the concept of a CD ladder, the general idea is rather simple. You divide your money up into equal amounts and use it to buy CDs with various maturities.

For example, let's say you have $10,000 set aside that you'd like to keep in cash, and you don't anticipate needing the money for at least the next couple of years. You could divide it into five equal $2,000 amounts, using one to open a one-year CD, one to open a two-year CD, and so on. Or, if you want to have immediate access to some of your savings, you could buy CDs with one-year through four-year maturities and leave the other $2,000 in a high-yield savings account you can withdraw from at any time.

The idea is that some of your money will be earning the high APY banks are willing to pay for long-term CDs, but you're leaving some of your money in shorter-term CDs and giving yourself more flexibility with the money than if you had put the entire amount in. And if interest rates rise over the next year or so (as most experts predict), a CD ladder can allow you to take advantage, as I'll explain in a bit.

How CD yields work

Generally speaking, the longer you're willing to leave your money in a CD account, the higher the yield, or APY, you can expect to receive. For example, here are the current yields for CDs of select maturities from a top online bank as of June 17, 2022:

Most of our other favorite CD institutions have similar yield structures as of this writing. The key takeaway is that you'll get paid significantly more on longer-term commitments. In this example, a $10,000 five-year CD would earn $115 in additional interest over the first year compared to a one-year CD.

Why a CD ladder makes sense

There are a few good reasons to use a CD ladder. Most notably, a CD ladder gives you some financial flexibility. It allows some of your money to mature at short intervals, so you don't have to tie all of your money up for long periods.

More importantly (in the current environment), a CD ladder can allow you to take advantage of rising interest rates over time. Consider the example where you spread $10,000 over five CDs with maturities ranging from one to five years. When the one-year CD matures, you can take that money and reinvest it in a five-year CD at whatever the then-current yield is. A year later, when the two-year CD matures, you can do the same. Eventually, you'll have all of the money invested in five-year CDs (at your bank's highest interest rates) and with one-fifth of it coming mature and available for you to potentially use in any given year.