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 monthâ€™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 thatâ€™s maturing isnâ€™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.