An emergency fund can be a lifesaver if you find yourself in a tight spot. But the amount of savings you have may vary depending on where you park your rainy day fund. While a traditional savings account is more secure than stuffing cash under a mattress, it won’t generate as much interest as a certificate of deposit (CD). Here’s everything you need to know about using a CD ladder to build an emergency fund.
What Is a CD Ladder?
Before you can understand what a CD ladder is, you’ll need to understand how certificates of deposit work.
A CD is a savings vehicle. But putting money into a CD is different from making a deposit into a regular savings account. With a savings account, you can withdraw money whenever you need it up to six times within a month or statement cycle. With a CD, you can’t make any withdrawals until it matures.
Maturity terms can range from three months to five years. Once your CD matures, you can withdraw the cash (along with the interest it’s earned) or roll it over into a new CD. Generally, the longer the CD term, the higher the annual percentage yield (or APY) is likely to be.
Building a CD ladder involves saving money in multiple CDs at once, with different maturity dates. For example, let’s say you have $5,000 that you’ve set aside for emergencies. You could put $1,000 into a 3-month CD, $1,000 into a 6-month CD and the remaining $3,000 into a 12-month CD. You can customize your CD ladder based on how long you feel comfortable leaving your savings locked up in CDs.
The Benefits of Using a CD Ladder for Your Emergency Fund
By sticking your savings into a CD instead of a savings account, you can build your emergency fund in less time. And if your CD has an interest rate that compounds frequently (like on a daily basis), you’ll watch your savings grow much faster.
As long as you space out your CD maturity dates appropriately, you won’t have to worry about sacrificing any liquidity. Ideally, you’d structure the ladder so that your next maturity date is always right around the corner. That way, if your car breaks down or you have an unexpected emergency you have cash on hand.
Read the Fine Print
Putting your emergency savings into a CD ladder can backfire if you don’t understand the CD’s terms. In many cases, the bank will assess a penalty if you withdraw money from a CD before it’s fully matured.
As you’re building your CD ladder, you’ll need to think about where you’ll get extra cash if you need money while you’re waiting for a CD to mature. The key is to find the right mix between short-term CDs that offer flexibility and long-term CDs with higher rates that can generate more interest on top of your savings.
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