If you’re looking for a relatively safe and steady way to grow your cash, consider a CD or bond ladder. These two strategies are designed to manage interest rate risk and provide periodic access to your cash.
But which option is better for your goals? Learn what CD ladders and bond ladders are, the key differences between them, and how to decide which one you should choose.
What is a CD ladder?
A CD ladder is a strategy in which you spread your money across multiple certificates of deposit (CDs) with staggered maturity dates. As each CD matures, you get access to a portion of your cash over time instead of waiting for a singular maturity date to access all of your funds at once.
This strategy can help mitigate risk by giving you the recurring opportunity to either renew individual CDs or withdraw your cash. It also lets you take advantage of whichever CD term is offering the best interest rate.
CD ladder example
Imagine you have $40,000 you want to deposit into CDs. The bank’s 1-year CD rates are the highest, but you don’t want to lock up all your money for that long to get the best rate. So, you set up a CD ladder, putting $10,000 into four different accounts with terms ranging from three months to one year.
When each CD matures, you can either renew it, choose a different term, or withdraw the cash and put it elsewhere.
Read more: Understanding CD renewal: Should you roll over a maturing CD?
Pros and cons of a CD ladder
Before setting up a CD ladder, consider these pros and cons:
Pros
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Regular access to cash: With CDs maturing at regular intervals, you have frequent opportunities to withdraw cash penalty-free, if needed.
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Regular renewal opportunities: When CDs in your ladder mature, you have the chance to renew them. If rates have gone up, you can lock in those higher earnings.
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Predictable returns: CDs offer fixed interest rates for the entire term, so you know precisely how much you’ll earn by the time each CD matures.
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Deposit insurance: CDs are a deposit product and therefore come with insurance on up to $250,000 per depositor, per institution. Depending on whether you open CDs at a bank or credit union, the FDIC or NCUA insures those deposits.
Cons
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Regular maintenance: A CD ladder isn’t a “set-it-and-forget-it” strategy. You’ll have multiple maturity dates to track, at which point you’ll have to decide whether you want to renew the CD, put the money into a different CD, or withdraw the cash.
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Less liquidity: CD ladders give you scheduled access to cash, but you can’t withdraw the money whenever you want. If you make withdrawals before a CD matures, you generally have to pay early withdrawal penalties.
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Interest rate risk: Because CDs pay fixed interest, you lock in your rate until maturity. If interest rates rise after opening a CD, you’ll be stuck with the lower rate throughout the CD’s term (with the exception of bump-up CDs).
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Inflation risk: If inflation outpaces your CD’s interest rate, your money will lose buying power over time.
What is a bond ladder?
Bonds are low-risk investments that pay you a fixed rate of return. For this reason, the “laddering” approach common with CDs also works with bonds. A bond ladder is similar to a CD ladder: It’s a group of bonds with evenly staggered maturity dates. Splitting your cash between multiple bonds gives you regularly scheduled access to maturing bonds and can help you adapt to a changing financial climate.
Bond ladders can include government bonds, municipal bonds, corporate bonds, and even bond ETFs. Compared to CDs, bonds often come with longer investment timelines — long-term bonds can have terms of up to 30 years.
Example of a bond ladder
Say you have $10,000 to invest in bonds. Instead of putting it all in bond that matures in 5 years, you spread it out over five different bonds with a range of interest rates and staggered maturities:
In this example, a bond will mature every year. At that point, you can reinvest the money by purchasing another bond or use the money elsewhere.
Note: Actual bond returns depend on the coupon rate, purchase price (premium or discount), reinvestment, and whether the bond is held to maturity. Some types of bonds, like savings bonds, require you to hold them for a minimum number of years before cashing in, otherwise you must forfeit a portion of the interest earned.
Read more: How to cash a savings bond
Pros and cons of a bond ladder
When building a bond ladder, keep these pros and cons in mind:
Pros
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Regular access to cash: Like a CD ladder, a bond ladder gives you regular, scheduled access to your cash. When bonds mature, you can choose to reinvest the cash or not, based on your current financial situation.
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Diversification: A bond ladder lets you diversify in multiple ways. By building a ladder with varying interest rates, maturities, and bond types, you can potentially reduce default, tax, and inflation risk.
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Regular payouts: Some bonds issue payouts at regular intervals throughout their terms, providing a predictable stream of income.
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Potential tax advantages: U.S. Treasury bonds, bills, and notes are taxed at the federal level, but not the state or local level. Municipal bonds may be exempt from taxes, too.
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Potential inflation protection: Treasury Inflation-Protected Securities (TIPS) provide a hedge against inflation. The principal increases or decreases with inflation, and at maturity, you either receive the original principal or the inflation-adjusted principal — whichever is greater.
Cons
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Ongoing maintenance: Bond ladders, like CD ladders, require ongoing maintenance and decision-making every time a bond matures. Again, you’ll have to track individual bonds’ maturity dates.
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Interest rate risk: When interest rates rise, the price of existing bonds decreases. So if you need to sell a bond before maturity, you might not get what you paid for it.
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Inflation risk: Aside from inflation-protected bonds, bonds in your ladder may lose purchasing power if inflation outpaces interest rates.
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Potential default: While bonds are considered low-risk, many carry a risk of default. Default is when the bond issuer fails to make required payments.
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Lower returns compared to other investments: While bonds carry little risk, that also means they don’t offer the same growth potential as other securities, such as stocks.
CD ladder vs. bond ladder: Key differences
How interest rates affect each laddering strategy
With fixed-rate CDs, you earn predictable interest throughout your CD’s term. Here’s how rising or falling interest rates can affect your CD ladder strategy:
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CDs and rising interest rates: When rates rise over time, you’re able to reinvest CD earnings as they mature at regular intervals, taking advantage of the new, higher rates. However, some of your money will be locked into longer-term CDs with the older, lower rates.
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CDs and falling interest rates: CDs generally continue earning interest at whatever rate you locked in when the account was opened. So, when rates fall, long-term CDs are advantageous. When a CD matures, you can decide whether or not to deposit it in a CD, likely with a lower interest rate, or use the money elsewhere.
When it comes to bond ladders, a similar principle applies. Regular maturities allow you to reinvest or not, depending on the current interest rate environment. However, because bonds can be bought and sold before maturity, there’s another layer to how interest rates affect bond ladder strategy.
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Bonds and rising interest rates: When interest rates rise, existing bond prices tend to fall. That can make it harder to sell bonds before maturity, and you may not get what you paid for them. However, when a bond matures, you can reinvest the money into a bond with a higher rate.
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Bonds and falling interest rates: When rates fall, your existing bonds become more valuable. But when they mature, you’ll likely need to invest them at lower rates.
Tax considerations
Interest you earn from a CD is taxed as ordinary income, just like your salary or wages. You generally have to pay taxes on these earnings for the year you receive them (or are entitled to receive them), even if you deposit it right back into another CD. If a CD has a maturity longer than one year, you still have to include part of the total interest due as part of your annual income.
Read more: How to avoid taxes on CD interest
On the other hand, bond ladder taxes are dependent on the type(s) of bonds they include:
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U.S. Treasury bills, bonds, and notes are taxed at the federal level but not at the state or local level.
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Municipal bonds are generally (but not always) exempt from federal taxes and may be exempt from state and local taxes.
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Corporate bonds are generally taxed as ordinary income.
In short, taxes on CD ladders are relatively straightforward, but taxes on bond ladders depend on the type of bonds that make up your portfolio.
Which should you choose: CD ladder or bond ladder?
Whether you choose a CD ladder or a bond ladder depends on your financial situation, risk tolerance, and goals. Your circumstances may be unique, but the following are some general rules to help you decide where to put your money.
CD ladders may be better for:
Bond ladders may be better for:
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Income-focused investors
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Retirees seeking higher yields
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Investors with larger portfolios
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Those willing to accept some risk for potentially greater returns
Can you combine CD and bond ladders?
Yes, you can combine CD and bond ladders — there’s no rule against it. But ensure each strategy has a unique purpose in your portfolio. For instance, a CD ladder might make sense for growing a portion of your savings over the next several years. Meanwhile, a bond ladder might be a longer-term tool to mitigate risk in your investment portfolio.
Keep in mind, however, that both CD ladders and bond ladders offer modest growth. If you’re trying to save for retirement, you’ll likely need stocks or other growth-oriented assets in your portfolio to reach your financial goals.
