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This article was originally published on Bankrate.com.
A CD ladder is a savings strategy where you invest in several certificates of deposit with staggered maturities to take advantage of higher rates on longer-term CDs, while still keeping some of your funds accessible in the near term.
With this strategy, you’ll redeem funds more often than if you put all of your savings in a long-term CD, while still reaping some long-term benefits.
How to build a CD ladder
Here’s an example of how to set up a CD ladder. Let’s say you want to build a five-year CD ladder with five rungs. If you have $2,500 to invest, then you might divide the funds equally into five CDs with different maturity dates:
$500 into a one-year CD at 3.5 percent APY.
$500 into a two-year CD at 4 percent APY.
$500 into a three-year CD at 4.25 percent APY.
$500 into a four-year CD at 4.35 percent APY.
$500 into a five-year CD at 4.5 percent APY.
When the first CD matures after a year, you can cash out or continue to build your ladder by reinvesting the funds into a new five-year CD with a higher yield. Then, when the two-year CD matures a year from now, use the proceeds from that account to open a new CD. Continue the process each year for as long as you want to maintain the CD ladder.
View this interactive chart on Fortune.com
The CDs don’t have to be the same amount, so you may opt to open each CD with varying balances to accumulate a higher yield. For example, you might want to invest more in longer-term CDs with high rates if you’re not in need of those funds. Just remember that there’s usually an early withdrawal penalty for withdrawing funds before the CD’s maturity date.
As you build your CD ladder, there’s no obligation to open all of your CDs at the same bank or credit union. In fact, it’s a good idea to shop for the best CD rates for each term.
Benefits of a CD ladder
CDs offer a guaranteed rate of return.
You can take advantage of higher rates on longer-term CDs without locking up all of your money for multiple years.
If rates continue rising, you can reinvest the money from shorter-term CDs into new accounts to lock in higher APYs.
You have easy access to your money if you need it (though early withdrawal penalties may apply).
Drawbacks of a CD ladder
Although CD rates have increased significantly over the past year, they’re still outpaced by inflation.
You could be missing out on higher returns from more aggressive investments, such as stocks or bonds.
If interest rates are declining, you might be reinvesting the money from a matured CD into lower rates.
Are CD ladders a good investment?
A CD ladder can help you build a predictable investment return. It also provides the potential to earn better returns than you would with a single short-term CD and the ability to access a portion of your savings each time a CD matures.
While there’s no risk of losing any of your money in an FDIC-insured CD, you could potentially miss out on the opportunity to earn a better rate if you reinvest shorter-term CDs when rates decline. Plus, you’ll potentially lose out on better returns offered by other investment vehicles with greater growth potential.
Consider your reason for opening a CD ladder before committing to one. It could be a great fit for your short-term savings goals, but a long-term savings effort might require an additional boost from other investment vehicles.
This story was originally featured on Fortune.com
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