Using A CD Ladder for Your Emergency Money

Written by , June 24, 2010

In today’s very low interest rate environment no one should be satisfied with receiving .25% (or less) on their savings. For emergency funds and other forms of savings a CD Ladder may be the best way to both get a higher interest rate, as well as maintain the flexibility to use this money if needed.

CD Laddering simply means buying a number of CDs with different maturity dates. By purchasing shorter and longer term CDs, you spread out the interest rate risk. You don’t earn as much as you would by locking in for the long-term, but you are able to take advantage of the market should interest rates rise in the interim. Today I am particularly in favor of combining a five year CD ladder with a high-interest money market account. This will provide some immediate access to money if you need it, and will also optimize your overall interest payments in the longer-term.

Here’s how it works. Say you have $12,000 that you want to invest in the 5 year CD Ladder strategy. You would divide that amount by 6, and invest it as follows:

Average Interest Rate*
1)    $2,000 in a high interest money market 0.29%
2)    $2,000 in a 1 year CD 0.74%
3)    $2,000 in a 2 year CD 1.18%
4)    $2,000 in a 3 year CD 1.52%
5)    $2,000 in a 4 year CD 1.74%
6)    $2,000 in a 5 year CD 2.04%

*Source:, June 21, 2010

The idea of this is to “ladder” the money among the different maturities to take advantage of the typically higher interest rates that are paid to CDs that have longer-term maturities. Note that the rates in the chart above are the average national interest rates; you can do much better if you shop around!

At the end of the first year you would reinvest the maturing CD in a new 5 year CD, thereby optimizing the interest rate you are receiving on your money. This process goes on and on every year. You may be thinking why not just buy the higher-paying, longest-maturity CD in the first place? Because by using the ladder approach you always have a CD maturing every year. This enables you to reinvest the maturing CD at the highest available rate, or cash it in without risk of loss should you need the funds.

By keeping the $2,000 in the high interest money market account you also have the flexibility to tap some of your savings at no penalty if you need them, but you are giving up some overall yield. You can eliminate the high interest rate money market account if you are sure you will not need to tap into that money. Also if interest rates were to rise rapidly, the money market account will provide some upside to you.

You can build your ladder at one financial institution, or once you get into the swing of it you can shop every year for a higher yielding 5 year CD online or at your local bank branch.

Here are some downside risks of a CD you need to be aware of:

  • If you withdraw your money from a CD before the maturity date you will likely pay an interest penalty.
  • If you are investing large sums of money in the ladder, be aware of the FDIC Insurance limits.
  • So start your CD ladder now, and be sure to shop around for the best interest rates on the bank money market account and the CDs.

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