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Banking

Want access to your savings while earning the best interest rates? How a CD ladder strategy can help

CD ladders combine short- and long-term CDs, so savers can tap their funds and earn higher rates.

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Certificates of deposits (CDs) may sound complicated, but they're just another type of savings vehicle banks and credit unions offer for you to deposit your money.

Like other types of savings accounts, they rewards you with interest. What makes CDs differ, however, is they traditionally offer higher interest rates in exchange for holding your money for a longer period of time. For this reason, CDs are a good option for savers who need an incentive not to touch their funds.

With CDs, you can't access the money you put in until your CD's term is up (known as the maturity date). CD term lengths vary, ranging between three months and five years, but usually the longer the term, the higher the interest rate (sometimes surpassing rates offered by the best high-yield savings accounts).

While you may feel inclined to choose a long-term CD and earn the higher interest rate, that means committing to lock up your money for more than a year. On the other hand, a short-term CD may give you quicker access to your savings after three or six months, but you don't earn the highest return.

This is where the CD ladder strategy comes in handy: With a CD ladder, savers spread their deposit across staggered short- and long-term CDs (instead of just one CD term). This way, they can tap into their funds more frequently in the short term and have a steady stream of cash while also benefitting from long-term CD rates.

Here's exactly how they work.

How to build your CD ladder

A CD ladder is a popular strategy for dividing your savings equally into multiple CD terms, rather than just one short- or long-term CD. By doing so, all your cash isn't tied up for a long time and you'll have staggered maturity dates. Once each CD matures, you can withdraw that money or, if you don't necessarily need it, reinvest it in a long-term CD.

By combining both short- and long-term CDs, you have flexibility and get the best of both of what short- and long-term CDs offer. Depositing a portion of your savings into short-term CDs delivers frequent access to your money at consistent intervals. Simultaneously, depositing another portion of your savings into long-term CDs lets you benefit from higher rates.

Like a buffet, you can choose any account you want to include in your personal CD ladder strategy. It's up to you: choose how much you want to deposit and how you divide up your savings, the number of CDs you want to open and their different term lengths. Before you decide, check what banks offer the best rates. You might decide on going with one bank for all the CDs, or cherry pick from several. It all depends how much extra work you want to put into tracking multiple accounts.

Here's an example of setting up a basic one-year, five-CD ladder with $5,000:

  • Initial deposit: $5,000
  • Number of CDs to divide savings into: Five
  • Term intervals: Every year, starting at a one-year CD

You would open the below five CD accounts on the same day:

  1. One-year CD: Deposit $1,000 (We recommend the CFG Community Bank CD)
  2. Two-year CD: Deposit $1,000
  3. Three-year CD: Deposit $1,000 (We recommend the First National Bank of America CD)
  4. Four-year CD: Deposit $1,000
  5. Five-year CD: Deposit $1,000 (We recommend the Ally Bank High Yield CD)

With the above CD ladder, every year will bring a new maturity date for one of your accounts. For example, if you opened the five CDs on December 13, 2020, your one-year CD will mature on December 13, 2021, your two-year CD on December 13, 2022, and so on. The CD ladder method definitely takes some organization as you will need to note down in a calendar the five different maturity dates on your five separate CD accounts, or however many you choose to open.

As one CD matures every year, you can choose to withdraw that cash if you need it, but you can't touch the funds of the other CDs until their maturity dates.

Better yet, reinvest the cash you don't use into a longer-term CD. By reinvesting those savings each year into separate five-year CDs, you maximize your savings potential, knowing you also have access to your funds should you need them in CDs that mature the following year(s).

Think you're ready to open a CD ladder?: Check out other factors to pay attention to when choosing the best CD for your money.

Bottom line

CD ladders can be a smart practice for maximizing your savings potential. As you consider whether CD ladders are a part of your saving strategy, know what your financial goals are in the short- and long-term. If you are saving up for something specific that has a certain timeline to it, perhaps putting one lump sum deposit into one CD account is the best move.

If, on the other hand, you don't have a specific goal in mind but want to earn as much interest as you can on your savings while also having predictable access to your funds, consider dividing your deposit evenly amongst multiple CD accounts to create a CD ladder.

Learn more: You can earn more interest when you put your money in a CD—here are the different types offered

Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the CNBC Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.