What is a CD Ladder?
CD laddering is a technique used obtain the highest possible interest rates while also preventing all of one's money from being inaccessible for a long period of time. In order to receive the highest possible interest rate, an investor normally needs to open a CD with a long term, such as 3 or 5 years. The problem with this situation is that the investor does not want his/her money to be tied up for that long. Interest rates may rise depending on the condition of the economy and the CD purchaser would want to take advantage of those better rates by opening a new CD. Also, the purchaser may find an altogether different, more lucrative investment part way through the CD term and desire to use the principal for that other investment.
A CD ladder can be used to alleviate this problem. Instead of putting all of his money in a high-yield 3-year CD, an investor can divide his money equally into three parts and open three different CDs. The terms for these CDs would be staggered; he would open a 1-year, a 2-year, and a 3-year CD. Although the 1- and 2-year CDs may have lower interest rates initially, the goal is to eventually get all of the investor's money into the long-term, high-interest (e.g. 3-year) CDs. After one year, the first CD will mature and the investor will put that money into a new 3-year CD. After two years, the second CD will mature and the investor will put that money into a third 3-year CD. Now the investor has all of his money in long-term, high-yield CDs, but the maturation date for the CDs is staggered. By using a CD ladder, the investor receives the highest interest rates while ensuring that a portion of his money will become available every year for use in new investments.
For a diagram of this process, see How To Start a CD Ladder.