Huddled around the water cooler with your fellow doctors, you can hear excited talk about the next hot stock to take off or how Frank in radiology made a killing in cryptocurrency. Some investing can be exciting, but you will probably never come across water cooler chatter about certificates of deposit (CDs).
According to Investopedia.com, a CD is an investment product offered by financial institutions that will give you a premium interest rate as long as you agree to leave a lump sum of money in their charge for a specific amount of time. Penalties are levied if the money is withdrawn before it is due. Like most other investments, CD interest rates fluctuate based on the economy. However, the rate that you agree to upon submitting your funds should be guaranteed.
Since you won’t be able to predict the future of CD interest rates, some financial planners recommend setting up a CD ladder. As discussed by Bankrate.com, this gives you the opportunity to benefit from potential interest rate increases while maintaining a relative amount of access to your funds. Here’s how it works.
Say you have $3,000 that you would like to invest. You would invest $1,000 in a 1-year CD with a 0.73% annual percentage yield (APY); you would invest $1,000 in a 2-year CD with a 0.79% APY; and you would invest $1,000 in a 3-year CD with a 0.84% APY.
After the first year is over, you would take your 1-year CD and put it into a 3-year CD. After the second year is over, you would take your 2-year CD and put it into a 3-year CD. In 3 years, all the CDs will be 3-year CDs, with a CD coming due each year.
Notice how the interest increased as the CD is committed to a longer period? If you put the entire $3,000 in the 3-year CD, you might get the highest rate, but your whole amount would be illiquid for 3 years. Also, if the 3-year CD rate increases in the following year, you wouldn’t be able to move any of that money to benefit from the increase. By laddering the CDs, you are giving your initial investment of $3,000 the chance to take advantage of an average of CD rates over the years, rather than being stuck on one rate, and you have access to some of the funds once a year.
Creating a CD ladder may not be the most exciting way to invest, but it is low risk and provides a great opportunity to diversify your investments.