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What is a CD ladder? How to build one — and capture high rates before they drop

What is a CD ladder? (twomeows via Getty Images)

The Federal Reserve held the benchmark interest rate unchanged at a 23-year high of 5.25% to 5.50% at its last rate-setting meeting on May 1, keeping APYs on certificates of deposit at their highest in decades, with some CDs paying up to 2 percentage points higher than the inflation rate.

But despite recent economic data pushing the timeline for anticipated rate cuts, lower rates are on the horizon for later this year. The question is when?

If you’re looking to climb your way to higher savings but aren’t ready to sacrifice access to your money, a CD ladder offers a way to lock in today’s highest rates while enjoying rolling returns at regular, timed intervals.

Here’s how a CD savings ladder works and how to build your own while interest rates are high.

A CD ladder is a savings strategy designed to take advantage of high CD interest rates without committing all of your funds to one long-term CD. Instead, you distribute your investment across a series of staggered maturity dates, guaranteeing regular access to your money as you grow your overall savings.

Typically, the longer the term of your CD, the higher the annual percentage yield on your deposit. Yet with rates at their highest in decades, you can find a range of terms offering APYs that earn at least 10 times the FDIC’s national average 0.45% savings rate, making a short-term CD ladder a low-risk way to boost yields on your savings.

Let’s say you have $10,000 to invest in a high-yield CD. You might put the entire lump sum into a long-term CD of 12 months or longer to earn a high rate of return. But if you were worried about needing access to at least a part of that money within the year, a CD ladder could break up your investment and space out your returns.

With a CD ladder, you’d divide your $10,000 investment into smaller amounts portioned across a series of CDs with different maturity dates. Many people divide their money into equal principal amounts, but you can break up the amounts you invest in each CD however you’d like.

Each CD becomes a “rung” on your CD ladder, with the ladder itself offering an overall yield.

Here’s an example of a short-term CD ladder of four rungs offering an average 5.05% yield based on today’s CD rates.

After each CD in your ladder matures, you have the flexibility of deciding what to do next. If rates were to drop later this year as expected, you could cash out your principal plus interest after each CD matures and move it to another investment vehicle offering higher yields. If rates were to increase, you could reinvest your matured investment into another CD with a higher rate or longer term.

Dig deeper: I'm a personal finance expert: Here's why you need to invest in a CD today

Determine how you'd like to split up the money you want to invest— and then invest those funds in different CDs with staggered maturity terms. Here's how.

  1. Think about how much you can comfortably invest. You’ll have access to your returns at regular intervals as each CD in your ladder matures, but it shouldn’t be a hardship on your budget.

  2. Decide on your number of rungs. Consider how frequently you’d like access to your money. Shorter terms provide more regular access, while longer terms might offer higher rates.

  3. Shop around for the best rates. Compare the highest yields available for the terms you’re interested in — whether with one financial institution for ease or across multiple banks to maximize your earnings.

  4. Open your CDs and invest your money. Keep track of each CD’s maturity date so you can build in the time to analyze APYs and either roll your balance into a higher-rate CD or cash out what you’ve earned

  • Capture and maximize high rates. Your money is locked into guaranteed high rates of return, even if interest rates drop later in the year.

  • Flexible investment cash flow. Staggered maturity dates provide you with rolling access to your money without the withdrawal penalties of one long-term CD.

  • Predictable rates of return. CD rates are fixed, which means they won’t change over the life of your term.

  • Your money is insured. CD accounts are insured for up to $250,000 by the Federal Deposit Insurance Corporation — or the National Credit Union Administration, if your CD is with a credit union.

  • Not a set-it-and-forget-it strategy. It can be easier to maintain your ladder if your accounts are with one financial institution. If not, you’ll need to monitor maturity dates to either roll your investment into another CD or cash out what you’ve earned.

  • Penalty for early withdrawals. If you need to access your money before a CD term expires, you face fees equal to several months of interest, depending on the account.

  • Minimum deposits may be required. While you can find CDs without minimum starting deposits, the highest rates may require $1,000 or more — which may limit how far you can spread your investment.

Dig deeper: When is it worth it to break a CD? A finance expert's thoughts on early withdrawals and breaking even

A CD ladder isn’t the only way to store your money while rates of return are high. Look to these alternatives when considering your investment options.

  • Long-term certificate of deposit. If you’re worried about falling rates and are certain you won’t need to access your investment principal, one high-yield CD could be easier to manage than several.

  • High-yield savings account. A high-yield savings account offers a way to quickly grow your savings investment at rates of 5% APY or higher with no penalty for withdrawals.

  • Money market account. The rate on a money market savings account can beat those of traditional savings accounts, with the same access to your money.

  • Higher-risk investments. Stocks, index funds and mutual funds average higher returns than CDs, though with higher potential losses.

Dig deeper: High-yield savings account vs. CD: What to know when rates are high

A CD is a type of savings or deposit account offered by banks, credit unions and other financial institutions. Unlike a traditional savings account, a certificate of deposit holds your money for a set period of time — terms of one month to five years or longer — paying out your principal and any interest you've earned only after the term expires or "matures."

Typical CD rates are fixed, which means the rate of return doesn't change over the life of your term. And while you can't add to or access your money until the CD matures, the trade-off is a higher yield than you'd find with a traditional savings account, making a CD a safe, stable way to grow your savings.

Kelly Suzan Waggoner is personal finance editor at AOL. Before joining AOL, Kelly was managing editor at Bankrate and editor-in-chief at Finder, where she led a team focused on helping people to make unfamiliar financial decisions around banking, lending, credit cards, investments and more. In addition to Bankrate and Finder, Kelly’s expertise has been featured in Nasdaq, Lifehacker and other publications. Today, she's dedicated to empowering those planning for, newly entering or fully enjoying retirement to get the most out of their finances — whether that's saving money, managing debt, maximizing rewards or growing their wealth.