Some Readers Favor CDs, Some Think It’s A Dumb Idea

by Kevin on September 15, 2008

Last week I wrote about how we were sticking our toes into CD laddering. Some readers thought it was a smart idea, others not so much.

Readers Start-Up and Shaun think that putting an emergency fund can be a risky proposition. Start-Up said it like this:

CD laddering is a good idea for when you lose your job and still need an income to pay the monthly bills until you find a new job. Ideally in this instance you would have one month’s worth of bills maturing at the beginning of each month.

The trouble with CD laddering arises when you need to dip into your emergency fund for a major purchase. Like when a large appliance breaks down or you have a rather large medical bill. If the value of the CD that’s maturing isn’t enough to cover this emergency you have to take a penalty by withdrawing from the CD.

Shaun also pointed out that the spread between a high-yield savings account and a CD is usually less than 1%. In his eyes, it isn’t worth locking the money away for that little of a premium.

A Quick Example of CDs Holding an Emergency Fund

These are good points. However, this isn’t our only form of savings either. Let’s say we have $3,000 saved up for a big vacation, and we have 3 different $1,000 CDs that will mature one per month for the next three months. If I had a $3,000 emergency (fairly large in my opinion), I would use that vacation money first before having to tap the CDs. If you type the vacation fund, it gets paid back over the next three months as the CDs mature.

Evan from My Journey to Millions was even more adament against CDs. He pointed to a post he wrote on the topic. In his post he calculates the difference in return with a 5% CD and a 3.75% high-yield checking account. The return is very small even for large sums of money.

Higher Premium Helps Fight Inflation

Again, a good point. The difference in the return isn’t too much especially in my case — only 0.75%. However, a higher return is still a higher return. With inflation running in the 4-5% range these days any extra premium helps fight the loss of the value of your money.

We Don’t Need Liquidity

If you don’t need the money during the term of the certificate of deposit, why wouldn’t you use one?

Look at this way: if you have extra money saved up for various goals in your savings account — and you leave that money in the savings account — you can tap that first before the CD. This is the situation we are in. We don’t have a significant need for liquidity from this money. Earning extra risk-free return seems like a win in this situation.

Again, I am not suggesting sticking your life savings into a CD. You could do the opposite and stick the money you have earmarked for specific goals into CDs that mature before the need for the money. I’m not a fan of this simply because I find us saving for many goals at once. We are constantly adding money to these goals.

For example, we are already putting money away to buy my wife a car in 2012. Yes, that’s four years away. We want to pay cash for the vehicle and not have a loan if we can prevent it. Each month we set aside money for this goal. If we put what we currently have saved for the car into a CD, next month we would have more money. What would we do then? Open up a new CD?

JD at Get Rich Slowly always says “Do what works for you.” For us, this plan works.

{ 3 trackbacks }

The Certificate of Deposit Debate Rages on! | My Journey to Millions
September 15, 2008 at 6:21 pm
Money Hacks Carnival #31 — Crisis And Bailout : Moolanomy
September 24, 2008 at 9:54 pm
Money Hacks Carnival #31 — Crisis And Bailout | TheOnlyDevice.com
October 9, 2008 at 12:40 pm

{ 4 comments… read them below or add one }

Matt @ Steadfast Finances September 15, 2008 at 8:44 am

Agree w/ you 100% that CDs are great ways to help you save. One year CDs staggered to expire every 3 months is an awesome idea for your emergency fund. Especially if you need that “something extra” to mature.

My only issue with CDs right now are those high yield saving accounts offering rates higher than any CD I’ve seen to date. Highest one I’ve seen to date is 5% @ 1 year CD at WaMu, but I think I’ll stick to my my 6% high yield savings account. It’s not guaranteed for any specified period of time… so I’m taking some risk but I think it’s worth it to stay liquid. Then again, I’m one of those evil minded traders!

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Ashley @ Wide Open Wallet September 15, 2008 at 9:36 am

We keep the bulk of our e-fund in a 6 month cd. About $7,000 out of 11,000. I’m not sure off the top of my head how much more interest we earn over a savings account, but it’s more so why not grab it?

We ended up doing that because I wanted to move our efund to an online savings account that was earning about 5% at the time. My husband didn’t like the idea of our money not being at a local bank. He wanted to be able to walk in and get cash in hand if we needed. So we compromised on the CD. It was earning 5% and we got to keep the money in our actual B&M bank.

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Russell September 15, 2008 at 3:50 pm

In a true “emergency” I think getting the last 1/4-percent out of my investment would become a secondary concern. The CD penalty for early withdrawal is often expressed as some number of months interest, and I’d think of it that way. If the roof had blown off the house three months earlier with a non-penalized withdrawal it would be the same effect.

Emergencies like the refrigerator stopped working, or the TV quit during football season, are easy to handle with no penalty. My refrigerator and my washing machine were interest-free from Sears if paid for within 12 months. Most of the home-improvement and large-appliance stores have similar offers. It gives plenty of time for those timed investments to mature and make the payments.

I used to have several overlapping CDs so that every month or two one would be available. I’ve still got one that’s been renewing for a long time, and I’m rebuilding an emergency fund into normal savings at the same local bank. I’ll decide later if I want to transfer from the savings into CDs again. I like the CD because of the guaranteed earnings, and it’s stuck there where I won’t touch it. Sometimes I need to protect against myself.

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Start-Up September 15, 2008 at 4:13 pm

Now that I think about it some more, I’m even more inclined to use CD Laddering once I have an emergency fund. The risk of having to make a large payment can be mitigated. I recently opened an AMEX credit card that has a 0% rate for three months, which would be enough time for my CDs to mature to pay off the debt before the rate increases.

I will always be one of those rate chasers. The difference between a 3.75% return vs. a 3.0% return might not be significant, but I will always take the option for more money.

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