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How to Beat a Certificate of Deposit (CD) Ladder

Building a certificate of deposit (CD) ladder is a great process that ensures you’re eventually earning the strongest interest rates available while leaving the possibility open to withdraw money every three months without penalty. In fact, even if you need to withdraw some money between the quarterly window, you would only be faced with a small penalty in the form of giving back some interest to the bank.

It is, however, a somewhat complicated process to set up. I do have a different suggestion if you want to keep a good amount of cash liquid or available, while earning some of the highest interest rates available, but without putting any of your money at risk.

Let’s start with the five-year CD at Discover Bank. Although you could earn a higher rate right now by investing in a ten-year CD, I don’t believe most people with a time-horizon should consider CDs appropriate investments. Right now rate as of October 8, 2013, five-year CDs are earning 1.65% APY at Discover Bank.

Unlike the CD ladder, this process is simple: invest all the cash you want to consider medium to long-term liquid savings in this five-year certificate of deposit. If you need to withdraw money early, you will be charged a penalty, but in most cases, even after paying this penalty you will earn more than laddering the CD using shorter-term maturities.

Here is why this works. The penalty for withdrawing cash early from a Discover Bank five-year CD is the amount of simple interest earned on the withdrawal amount for six months. For example, if you open a $10,000 CD with an interest rate of 4% APY on January first and withdraw $1,000 on March 31 of the same year, your penalty is $20. Your balance is reduced to $9,000, so instead of earning $400 in interest throughout the year, you earn $370 in that first year, minus the $20 penalty. That works to about about 3.78% APY, only slightly off from the original interest rate, and likely still higher than the interest rates offered on shorter-term CDs.

You could play with these assumptions and come up with results that make simply buying one five-year CD less attractive, particularly if you expect to withdraw larger amounts more frequently. However, for many people, this is a technique that, without withdrawals, will earn you more, and will leave your finances in a much simpler state. Simplicity is a key principle for financial success, something I don’t stress often enough on shizennougyou.

What are your thoughts on this technique? Is the possibility of earning a penalty enough to encourage you to maintain a fully-structured CD ladder or are you willing to take the risk for the sake of simplicity?

By the way, if you’d prefer to work with a different bank, Ally Bank offers attractive CD interest rates, as well.

Updated June 9, 2015 and originally published April 16, 2010.

About the author

Luke Landes is the founder of shizennougyou. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about Luke Landes and follow him on Twitter. View all articles by .

{ 6 comments… read them below or add one }

avatar 1 Anonymous

For me personally I think US I Bonds are a better deal than the current CD rates (at least for now) Currently this month are 3.36% return (tax free until withdrawn). Not sure next month’s fix rate will be.

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avatar 2 Anonymous

That works in higher-rate environments, but I expect you’ll kill your relative performance as rates rise over the next 3-5 years. You don’t want 3 yrs left on a 3% CD when new 5yr CDs are yielding 6-7%. I also agree that I Bonds look good right now.

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avatar 3 Anonymous

I have given this whole thing considerable thought because as an association board member we have funds that we want to get returns on.

I have considered the exact scenario you point out above and I think the penalty for early withdrawal easily accomodates that situation.

Given that most of the penalties for early withdrawal are loss of 6 months interest (sometimes up to 1 year). If you have 3 years left on a 3% CD and its now yielding 7%, you just break the CD, take a 6 month penalty (which is 1.5%) and roll it into the new 5 year CD at 7% and the cost to do so is minimal compared to the huge increase in interest rate you get in the new CD.

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avatar 4 Anonymous

I’ve read a lot of poor reviews regarding Discover’s banking website and customer service. Does anyone here know if that has changed? I’ve always had good luck with their credit card site and service.

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avatar 5 Anonymous

Agree completely. Opened up 5yr CD, except used Ally Bank. Only 60 day penalty for early withdrawal. Keep the CD for a year, you still earn 2.50%-easily beating the one year CD rate

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avatar 6 Anonymous

If Discover is offering 4% APY then its true that the penalty for a withdraw will only be $20.00 which is not as hefty as some other banks. But Ally and State Farm also offer around 2.5% rates which is a bit of a competition now.

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