I Wouldn't Take Any Other Approach Than This One to Opening a CD

Some people don't like the idea of putting money into a certificate of deposit, or CD. I've heard people say that it's too much of a commitment, and it's not worth the upside of what's often just a slightly higher interest rate than what a savings account will offer.

But it's not just that CDs commonly pay more interest than savings accounts. It's also that they guarantee you the interest rate you sign up with for a preset period of time.

My savings account is currently paying me 4.3% on my money. But a few months from now, my savings' interest rate could drop to 4.1% or 3.8%, and there's nothing I can do about it (other than perhaps shop around for a bank that's paying more generously).

However, if I lock in a 12-month CD right now at 4.7%, I'm guaranteed that rate for a full year, regardless of market conditions. And that's a nice thing.

But while I'm a fan of CDs, I'll only take one approach to opening them -- using a ladder. This way, I'm less likely to end up in a jam.

When your money frees up at regular intervals

The downside of opening a CD is that you're committing to keeping your money in the bank for its duration. And if you cash out a CD before it matures, you could face costly penalties.

These vary by bank, and they commonly hinge on the term of your CD. But the penalty for cashing out a 12-month CD early could easily be three months' worth of interest.

And it doesn't matter how early you redeem your CD before it matures. You'll face the same penalty whether you cash out your CD six months early or six weeks early.

That's why I make a point to ladder my CDs rather than put all of my spare cash into a single CD. That way, my money is freed up at regular intervals, so I'm less likely to face a scenario where I risk being penalized for cashing out a CD early.

How to set up a CD ladder

Setting up a CD ladder is pretty easy. You simply take the amount of money you're willing to put into CDs, divide it into a few batches, and then open a new CD every few months.

There's no exact science. The key is just to make sure you have a CD coming due every so often so you have access to some of your money when you want it.

So, let's say you have $10,000 you're interested in putting into a CD at the start of the year. Rather than open a single 12-month CD, what you'd potentially do is open a $2,500 CD with a 12-month term in January, another 12-month/$2,500 CD in April, a third in July, and a fourth in October. That way, you have $2,500 freeing up every three months.

Of course, this is just one example. You could set up a CD ladder that has money becoming available every month if you want. The point is simply to avoid a situation where you need access to your money but can't get it because it's in a CD, or risk a penalty for an early cash-out.

And speaking of avoiding penalties, another rule I follow with CDs is to never put my emergency fund into one. Since that's money I might need at any time, I wouldn't want to tie it up for any preset period -- even if I'm using a laddering strategy.