Opening a CD Now That Rates Are Higher? You May Want to Take This Approach

It could lead to better rates and cash flow. 

For years on end, putting money into a savings account meant collecting such minimal interest it was barely worth it. And while CDs (certificates of deposit) normally pay higher interest than savings accounts, their rates were stuck in stingy territory for years, too.

But over the past number of months, the Federal Reserve has been implementing interest rate hikes in an effort to slow the pace of inflation. That's bad news for consumers on one hand, because it's led to an uptick in interest rates across a range of borrowing products, from auto loans to personal loans to credit cards.

But higher interest rates can spell good news for people with money to put in the bank. Not only are savings account rates up right now, but CDs are offering some of the best rates consumers have seen in years.

As such, you may be tempted to lock up some of your money in a CD. But if you're going to go this route, it pays to employ a specific strategy -- laddering.

How a CD ladder works

If you have $10,000 to put into a CD right now, you could dump that entire sum into a single CD. Or, you could spread it out across different CDs with different maturity dates. The second approach is known as laddering, and it's a smart one to take for a couple of reasons.

First, if you ladder your CDs, you won't tie up all of your money at once. Rather, you'll have CDs coming due at different times, thereby freeing up your cash at different intervals.

Second, building a CD ladder could make it easier to capitalize on rising interest rates. Let's say you lock up all of your money in a single CD paying 3%. What if rates rise to 3.3% a month later, and 3.6% a few months after that? Suddenly, you've lost out on the chance to snag a higher return. But if you stagger your CDs, you might manage to jump on those higher rates as they come down the pike.

How to build a CD ladder

Building a CD ladder is simple. All you do is take the total amount of money you want to save and divide it across a few CDs maturing at different times. 

For example, you might take your $10,000 and divide it into four. From there, you might open a $2,500 one-year CD in November, a second $2,500 CD in February, a third $2,500 CD in May, and a fourth $2,500 CD in August. That way, your money frees up at different points during the year rather than you having to potentially wait months to get access to your cash.

Remember, cashing out a CD before its maturity date generally means losing a few months' worth of interest as a penalty. Laddering your CDs can help you avoid that scenario. 

Now, if you're only looking to save a small sum of money -- say, $500 -- a CD ladder may not be necessary. But if you're looking to sock many thousands of dollars away in a CD, then it pays to consider a laddered approach -- especially since CD rates now have the potential to keep climbing.