If you are nervous about the seemingly unsustainable upward trend in the market, you are not alone. I have been treading cautiously, being conservative with my investments. To hedge against a potential crash, I have been squirreling money away in a savings account with dismal rates, until I discovered the CD (Certificate of Deposit) ladder. In this post, I will show you its beauty and how to build a CD ladder yourself with Vanguard.

Not sure what a CD is? In short, a CD provides a way to save money risk free as you enter into a contract with an institution to deposit your money for a certain amount of time before maturity. Investopedia explains it in more details.

Because longer-termed CDs offer higher rates, they represent higher returns, but investing only in long term CDs at the same time will tie up your funds for that duration. CD terms can range from 1 month up to 10 years with rates from .025% to 5% (for example). Of course, if you want to maximize your investment, purchasing longer-termed CDs will yield those juicy returns. The solution: build a CD ladder.

What is a CD ladder

A CD ladder staggers the maturity interval of your CDs. Using this method, you capitalize on the highest rate CDs while maintaining accessibility to your funds. The initial ladder combines short and long term CDs. Once you hit the second ladder, all CDs will be the highest rate.

The figure below depicts this strategy. For this example, we use CDs that range from 1 to 5 years in maturity for simplicity.

The orange bars represent the initial ladder. In this ladder, you buy 5 CDs at the same time, with the terms highlighted by the top number. The corresponding rates are shown for each CD. You can see a significant difference between rates based on terms.

The left vertical bar represents elapsed time. As shown, after the first year, the first CD at .5% interest rate will mature. At this point, you will buy another 5-years term CD at the highest interest rate. You will repeat this purchase yearly. Eventually, you will own only the highest rate CDs, and every year one of them will mature. Cha-ching!

Advantages of a CD ladder

When you stagger the maturity interval in a CD ladder, you position yourself to capitalize on potential rate increases. If interest rate rises, you can lock this new higher rate in the following year. If you had bought 5 CDs at the longest term initially, your funds would be locked in and you will potentially miss out on the higher rate.

Additionally, if you need the money in an emergency, you can cash the CD closest to maturity for maximum returns, even with the fees associated with an early withdrawal.

Lastly, every year you can count on a CD maturing. If you have ever played Monopoly, you might remember the card that gave you $200 for when “stocks mature.” Remember how epic that was? Well, now you can have that in real life every year.

How to build a CD ladder

Numerous banks sell CDs, but I prefer to use Vanguard to build my CD ladder. The biggest advantage of using Vanguard is the selection and ease of creating a ladder. As a broker, Vanguard offers CDs from multiple banks, giving you the best CD rates in a single account so you do not have to open 3 different accounts with 3 banks to take advantage of their CDs.

Vanguard also provides a built-in ladder option, meaning you can build and visualize your ladder before committing to any CD. This means you can play around with various ladders to find the best one for your situation.

The only drawback to using Vanguard is the high CD minimum, currently $10,000. Therefore, if you want to build a 5-steps ladder, you need at least $50,000.

Other brokers might offer CDs as well such as Schwab, but I have not seen one with a ladder tool.

If you have a Vanguard account and want to test build a CD ladder, log into your account and under the “Invest” tab, select CDs. On the next screen, select “Buy CDs.”

The next page provides a listing of new-issue CDs, their terms, and rates.

When you click on the rate, a listing of the banks offering the CDs at this term will be shown. Next, click the checkmark for “Add to ladder” on the CD you want. When asked, select “New ladder.”

Now go back to the page listing and repeat the steps until you have built a ladder to your liking. The figure below depicts a ladder with CDs ranging from 12 months, 18 months, 2 years, 3 years, and 5 years.

With your CD ladder built, you can review several metrics associated with your ladder including the “cash flow” feature. This particular view shows you when distributions will be made from all the CDs on a yearly calendar.

To purchase the ladder, simply click buy on each of the CD in your ladder and you are set. Lastly, set a reminder to come back at the same time next year to lock in the next step in your CD ladder with the longest term CD in your initial ladder.

A diversified portfolio

Investing in CDs provides a safe strategy as part of your overall portfolio. To hedge against possible downturns in the market, putting money in cash investments gives you modest returns in exchange for peace of mind. However, you can maximize your gains when you build a CD ladder and take one more step toward financial independence.

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