CD ladders use to be a good way of saving funds and gaining more interest on those funds than you would with just a simple savings account. CD ladders combine the best of both long term earnings and more frequent access to a portion of your money. If you’ve never heard of a CD ladder, I’ll give you the basic run-down. Say your bank offers CD’s of up to five years and you have $20,000 total to invest. Instead of purchasing one CD for $20,000, you will split your money up. $4,000 per each year. At the end of year one when your CD has matured, you can either use your money or renew into your longest term CD, or in this case a 5 year. Reinvesting into the longer term will give you a better return on your money and the next year you can still access the same amount.
This use to be a great way to get a higher rate of return on your money and still have access to it. Many people, otherwise, don’t usually choose the longer-term CD’s because they don’t want to tie up their money for so many years and if they do have to close them early suffer large penalty fees. But is it really worth it now with interest rates so low? Do CD’s ladders still offer a greater “best of both worlds” approach?
Let’s consider the highest rate banks of today. If we use Ally bank’s rates there are several options to choose from, let’s pretend you have $5,000 you won’t need for at least 5 years, maybe longer, You could make a ladder like this:
- Rung 1: $1,000 in an 11 month No Penalty CD at .87% APR
- Rung 2: $1,000 in a 2 year Raise your Rate CD (with 1 opportunities to raise the rate over the next 2 years if the APR changes) at 1.30% APR
- Rung 3: $1,000 in a 3 year High Yield CD at 1.50%
- Rung 4: $1,000 in a 4 year Raise your Rate CD (with 2 opportunities to raise the rate over the next 4 years if the APR changes) at 1.40%
- Rung 5: $1,000 in a 5 year High Yield CD at 2.00%
With the ladder approach, your total earned interest after 5 years is $435
Now say you just took that $5000 and put it into a regular savings account for 5 years at the current 1.00%: total earned interest is $251.25.
However, the total earned interest putting $5,000 in a 5 year CD is $525.84, which is obviously more than making a CD ladder. If you had to early access your money, you will pay a penalty of about 150 days of interest in a 5 year term.
So what is the answer? Are CD ladders worth the fuss of re-upping every year or should you just “Set it and forget it” as some say. If you are positive you won’t need that money for the next five years, I would suggest just putting all your eggs into one basket; but then on the other hand, who can ever be sure they won’t need money? Murphy is not anyone’s friend, you never know when your house catches fire and you need that money (or some other horrible scenario) so I guess it just comes down to situations and choices, you decide.