Should You Use CDs For Your Emergency Fund? Should You Use CDs For Your Emergency Fund?
Certificates of Deposit (CDs) are an interest-bearing deposit account that offer a fixed interest rate for set term. Since they generally offer higher interest rates than traditional savings accounts, CDs can be a lucrative option for growing your savings when you have a lump sum you're looking to invest.
However, if you're looking to grow savings that you've set aside as an emergency fund, there are several reasons that a CD might not be the best option. We'll explore that and more below.
How Do CDs Work?
Before we discuss why CDs might not always be the best fit for investing your emergency fund, let's talk a little bit about how CDs actually work. As we mentioned above, CDs are a deposit accounts offered by most banks and credit unions that allow individuals to receive a fixed interest rate for a specified period of time, or “term.” CDs come in various terms ranging from a couple of months to five years and usually come with a higher interest rate than conventional savings accounts. Another defining characteristic of CDs, and definitely one to consider when deciding whether this account type is the right fit for your emergency fund savings, is that you have to leave your funds untouched for the duration of the account term. Most CDs have early withdrawal penalties attached so that if you do withdraw all or a portion of your funds before the account's maturity date, you'll be assessed a fee.
How Do CD Early Withdrawal Penalties Work?
In the event of an emergency, you'll always be able to withdraw your funds from a CD account, but most financial institutions will likely assess you a penalty fee for doing so. When you open your CD, your financial institution will clearly stipulate in the account terms how they will handle an early withdrawal. These penalties are most commonly assessed on the interest you've gained before you get your money back. Generally, the longer your account term the more month's interest you'll be assessed.
So how should you take all of this information into account when deciding whether to use a CD to grow your emergency fund savings? Let's dive in.
What Are the Drawbacks of Using CDs for an Emergency Fund?
By now you might be getting a sense of why CDs aren't the most conducive option to grow your emergency fund. By nature, you'll likely want to have your emergency fund available at the drop of a hat in the event that you need to use it for something unexpected. Think along the lines of unanticipated car repairs, medical expenses, or surprise house expenses. When something like this pops up, you want to be able to have immediate access to your emergency fund.
While CDs are a great option to grow your savings because of the interest rates they offer, the lack of flexibility to access your funds can be prohibitive when it comes to emergency fund investment options. However, if you're just getting started building up your emergency savings and want to quickly grow an initial seed investment that you won't need access to immediately, a CD could be a good option. Leader Bank offers several exclusive high-yield CD options for six- and nine-month terms to help you grow your savings without tying your funds up for the long term.
What Kind of Account Should You Keep Your Emergency Fund In?
If you're looking for an account that will offer a higher interest rate than a traditional savings account with more liquidity than a CD, there are several accounts that fit the bill.
High-Yield Savings Accounts
A high-yield savings account, or HYSA, is a type of savings account with a higher interest rate than conventional savings accounts. Unlike CDs, you can access deposited funds in a high-yield savings account whenever you need to without penalty. Another key difference is that high-yield savings accounts have variable interest rates, meaning your rate can change after you open your account as interest rates are hiked or cut by the Federal Reserve.
Money Market Accounts
A Money Market account is another type of deposit account that combines some of the features of traditional checking and savings accounts. Similarly to savings accounts, money market accounts allow you to earn interest on your account balance. And like checking accounts, money markets offer the convenience of being able to withdraw funds from your account with a check or debit card at will. Leader Bank Money Market accounts offer tiered interest rates, so that you'll earn more on your savings the higher your account balance is.
Short-Term CDs
As we mentioned above, if you are just starting your emergency fund savings or have a chunk of savings you know you won't need to access for a few months, a shorter-term CD could be a good option. You'll enjoy a higher interest rate than most of the other options we outlined here.
If you really want to take advantage of higher CD rates while maintaining a level of liquidity with your savings, you could also consider a CD ladder strategy.
What is a CD Ladder Strategy?
A CD ladder strategy is an approach that involves opening multiple CD accounts with different maturity dates to take advantage of CD rates while keeping a portion of your savings liquid at all times. By spreading your savings across a mix of longer- and shorter-term CDs, you'll be able to take advantage of the higher rates of long-term CDs while maintaining liquidity through shorter-term CDs. When a shorter-term CD in your ladder matures, you can either renew the account, reinvest the money into another type of savings account, or use it for immediate cash needs,
So what does a CD ladder strategy look like in practice? Here's an example of how $5,000 invested in a five-year CD ladder would work:
- $1,000 in one-year CD
- $1,000 in a two-year CD
- $1,000 in a three-year CD
- $1,000 in a four-year CD
- $1,000 in a five-year CD
When each CD matures, you can reinvest the funds into a new five-year CD to continue the ladder, invest the money elsewhere, or use the funds for other savings goals.
How to Get Started Saving With a CD
If you're interested in growing your savings with a CD account, Leader Bank offers a range of Certificate of Deposit accounts with terms ranging from one month to five years. Opening an account can be done online and takes just a few minutes to get started!
