Let us say you have $300 and you invest it in a 1 YR CD at an 1.05% APY and you renew it every year. Over a three year period, here is what it would look like:
- Year 0 = $300.00 (this is when you invested)
- Year 1 = $303.15
- Year 2 = $306.33
- Year 3 = $309.55
Your total yield is $9.55 over a 3 year period.
If instead, you split the $300, and invested it into three CD’s as follows:
- $100 in a 1 YR CD (1.05% APY)
- $100 in a 2 YR CD (1.29% APY)
- $100 in a 3 YR CD (1.50% APY)
Here is what the yield would look like:
- Red Color Cells = indicates holding period.
- Green Color Cells = indicates that CD vests and is being reinvested.
- At the end of YR1, the 1 YR CD vests – you reinvest it in a 3 YR CD and it starts providing yield at the 3 YR CD rate.
- At the end of YR2, the 2 YR CD vests – you reinvest it in a 3 YR CD and it starts providing yield at the 3 YR CD rate.
- At the end of YR3, the 3 YR CD vests – you reinvest it in a 3 YR CD and it starts providing yield at the 3 YR CD rate.
You keep repeating this process. Once the process is established, you will see that 1 CD vests every year and is available for you withdraw or reinvest. How deep you go on your CD ladder is totally up to your discretion.
With CD laddering, your total yield was $12.56 over a 3 year period with the same $300 invested. In this particular case, you earned 31.55% greater yield by laddering your CD’s than investing in 1 YR CD and renewing it annually. Ally Bank has a nice CD Ladder Calculator to show your yields and comparing it against renewing your CD’s annually.
Over the past few years, people have been pulling money heavily out of CD’s given that we have been in low interest environment for the past several years. As we are approaching a potential raise in interest rates, it would be good to start laddering CD’s once we see the first interest rate hike.