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When the Federal Reserve cuts short-term interest rates, as it did yesterday, you feel the pinch in your savings account. My ING Direct account, for example, has dropped from 4.50% when I opened it to 3.65% today. It may drop again.
Brian from The Job Bored dropped a line with a money hack for those who like to chase the highest interest rates. “Why not buy protection?”, he wonders. Here’s how:
Since ING makes it free and easy to open a certificate of deposit [CD], every time I see another interest rate drop coming, I just throw more money into a 6-12 month CD, which locks in the higher rate.
I’ve been doing this since before Thanksgiving, and actually just did it again yesterday. I was watching CNBC and they were all saying a rate cut was certain. I now have about 40% of my savings in CDs, earning an average of 4.90%.
This may not seem like much, but it’s a way to assure higher rates for a bit longer. Plus, ING doesn’t drop their rates instantaneously. If you buy the CD a little ahead of time, you can beat the decrease.
I still haven’t opened a certificate of deposit — I’ve never had spare money to do so. But as soon as I’ve saved all of my $10,000 emergency fund, I’ll begin to look at them more closely. I’ll also be certain remember Brian’s trick for the future. It’s yet another way to squeeze more from your hard-earned dollars!
This article is about Investing, Money Hacks Thursday, 31st January 2008 (by J.D. Roth)
January 31st, 2008 at 11:26 am
Each time the feds cut rates, I keep being tempted to move some of my savings account into CDs. Then I remember that, in theory, that’s an emergency account, and that CDs aren’t sufficiently liquid for emergencies and I resist.
January 31st, 2008 at 11:36 am
I agree with Cameron…as tempting as a slightly higher rate from a CD is, for emergency account purposes I don’t know if it’s worth the loss in liquidity.
January 31st, 2008 at 11:36 am
Cameron - you can set up a staggered CD system to compensate for that. In addition to a one month liquid emergency fund (to cover you your first month into a job loss or some other emergency) you would have a CD maturing each month of the year. Each CD would contain one month worth of expenses and mature shortly before the beginning of the next month. For example a $2000 dollar CD to cover your Feb expenses which matures on Jan 26th or so (to give you time to transfer the money into a more liquid account). I have something like this set up (though not yet for all 12 months - still working on that). The easiest term to use is 1 year. After a year you can decide if you want to roll the CD over or move it to another investment vehicle or account.
It takes a bit more active managment of your finances but most of the work is up-front in setting up the CDs. After that it’s easy to just sit back and let them do their work.
January 31st, 2008 at 11:39 am
While ING’s interest rate drop isn’t instant, it is pretty darn close. I like ING and use them, but I have noticed that they are about the quickest to drop when the fed does.
@Cameron:
Do a CD ladder so you can have access to cash every month or two (depending on the ladder you set up).
January 31st, 2008 at 11:43 am
The staggered CDs are a clever solution, but doesn’t that approach assume that the only potential emergency is being out of work?
January 31st, 2008 at 11:52 am
For whatever reason EmigrantDirect does not drop as fast (or maybe just not as much) as ING. After the fed cut last week they did drop but only from 4.55% to the current 4.3%. Just a friendly FYI.
January 31st, 2008 at 12:03 pm
This is a fantastic idea, I didnt even think about that. Still, Ive always been wary of CDs because of the penalties incurred if you need your money in a hurry, ie emergency. ING has disappointed me but hopefully when I check out bank deals, they’ll have something in the works. Unfortunately with all the rates going down though, it looks bleak. But the good idea as you’ve suggested is to lock it in a CD so you’ll be afloat even while rates go down.
January 31st, 2008 at 12:11 pm
“The staggered CDs are a clever solution, but doesn’t that approach assume that the only potential emergency is being out of work?”
Good point. I mentioned keeping one month’s expenses in the liquid account but you can keep more there if that’s more comfortable or if it’s likely your emergency might be an expensive house or car repair.
It’s a trade-off. In general the more liquid your funds the less they’ll earn in fixed interest. So you have to weigh the likelyhood that you’ll encounter a *major* emergency (one that would exceed one month of living expenses) before your next CD matures.
To be honest that’s what I do. I have about 3 months living expenses in a liquid account and then CD’s spotted throughout the year. I don’t expect any emergency - even a major hospitalization - would require over one or two months of living expenses *immediately*. Payment plans (or at the very worst family loans or credit cards) can cover the shortfall.
Another option is to set up the CDs with minimal amounts (the opening minimum) and see how the whole idea works for you. That way you’ll have most of your emergency fund available and when the time comes to renew or cash-in the CDs you’ll have (hopefully!) more money to allocate to them. This way you can build up your CD ladder without locking up your immediate emergency funds.
January 31st, 2008 at 12:11 pm
IMO, an emergency fund is money you plan on not spending. So it doesn’t matter if it’s in CDs. In the worst-case, emergency scenario, you liquidate the CDs and pay the early withdrawal penalties, which usually means forfeiting a few months’ interest–not a big deal.
One way to mitigate this is always to open a CD with only the minimum deposit. So if you have $10,000 to put away and the CD rate is valid on deposits as low as $1,000, open ten $1,000 CDs instead of one $10,000 CD. If you need $2,000 in a hurry, you can liquidate two of the CDs and leave the other $8,000 intact. Combining this strategy with laddering is even better.
January 31st, 2008 at 12:16 pm
A decent idea - but with early-withdrawl penalties, look out! Also, you’re playing the rate game, which subjects you to interest rate risk. If you lock up your money for a year or two (or longer), it’s possible the fed funds rate could rise and drop back down again during that time - leaving you unable to take advantage of higher rates in the interim. I like having maximum flexibility with my money.
Smart in some cases, but probably a wrong idea for “emergency, on-hand” cash. I like to use CDs when I have a goal in mind for my money, like saving for next year’s Christmas shopping or a trip I want to take next summer.
January 31st, 2008 at 12:19 pm
I think once my finances settle down a bit (mid to late 2009), I’m going to explore the CD idea further, and perhaps look at some other investing options as well. I have so much in flux at the moment that I don’t dare tie my money up in any way because I’m quite sure when I’m going to need it. haha, I’m afraid of commitment, where are the one month CDs!?!
January 31st, 2008 at 12:27 pm
Anne hit the nail on the head. The penalty for early withdrawal of a CD is a few months’ interest, at least at the few insitutions where I’ve ever had them. For a $1000 CD at 4% annual interest, that’d be on the order of $10. Not a big bite.
We have a little bit of a CD ladder. One of my financial goals for the next several years is to beef it up considerably. I find that having that money locked in is a nice barrier against spending it. When I think about “cash on hand” for everyday expenses, even unanticipated/atypical expenses, I don’t even usually think of the money we’ve got in CDs.
However, when I do mentally map out what we’d do if we had a really big financial problem (like job loss), it is nice to know that it’s there if/when we need it.
January 31st, 2008 at 12:40 pm
Check out this post I wrote last week on CD laddering - that’s what’s being described here. I have several clients who do this and it works very well.
http://bankergirl.com/archives/56
January 31st, 2008 at 12:42 pm
Due to a variety of happy windfalls, I’ll be coming into a nice chunk of change in a couple of months. In order, the priorities are:
1. Pay off remaining credit card balance.
2. Put a couple kilodollars in son’s 529.
3. Pay a couple of months ahead on car loan.
4. Use what’s left to open six six-month CDs, so one matures each month. Consider this the emergency fund.
January 31st, 2008 at 1:12 pm
CD laddering is a great option, but BOA used to have a “no risk” CD that paid out at near regular CD levels, but allowed you to pull money out at any time (but in person) with no penalty.
I’ve been using one as my “savings account” for almost a year now.
January 31st, 2008 at 1:17 pm
Hi. I’m the Brian mentioned in the post. I wanted to address a few things from the comments.
1) About the emergency fund. First, my savings account is not exclusively my emergency fund. It’s my savings account. I have an emergency fund in a local bank that I’d have quicker access to than ING.
2) Also about the emergency fund. Notice what I said in my email to JD: I only have 40% of my money in CDs. Id love to have put 100% in, but I specifically did not to be on the safe side. I’m just pointing out that you can shelter SOME of your money. If you only had $100 in your ING account, you could take out a $10 CD. ING doesn’t care. The whole point is to make those few extra pennies interest on some of your money.
3) I wholeheartedly endorse the laddering comments. Again, ING has no minimums for CDs. You could set up a quick and simple ladder with $30 say. Get a six month, nine month and 12 month cd. Repeat every month. After 12 months, you’d have the same amount coming due every month as invested.
4) About timing… look, it’s not foolproof… but all week if you paid attention to the stock market AT ALL, basically they were saying the rate cut was coming. So I took a calculated risk. If I was wrong, then eh, I was tied up for 6 months. But I bought a couple of days before the announcement and was rewarded. I’m not talking about logging in 5 minutes after the Fed announced… I’m talking about anticipating likely cuts and buying a couple of days ahead of time.
5) Penalty for taking money out of ING CDs is 3 months interest, I think. Really not that damaging.
January 31st, 2008 at 2:03 pm
@Chris[13]
As far as I know, that offer is still good. In fact, I just signed up for one with about 70% of my savings last week. I’m a huge advocate for using something like this, since the biggest risk of CDs - timelock - is almost completely mitigated out (the fine print states that a week’s warning MAY be required to withdraw without penalty). If one has a BoA account with a bunch of money just sitting around, there’s really almost no excuse to NOT have one of these.
January 31st, 2008 at 2:04 pm
I don’t have any CD’s but if you were in a rate “slump” with CD rates you hold greater than the current CD rates, you can often sell them if you want you money out. I only know this because a friend of mine bought some CD’s at Edward Jones, and this is the system he described. Apparently, Edward Jones does the work of selling them for you.
January 31st, 2008 at 2:18 pm
I’ve been using INGDirect CDs for my emergency fund. Every month I opened another one, term 6 months, because I used to have a serious ‘borrowing from myself’ problem. It’s not yet under control, but I’m working on it.
I emailed and asked, ING has no limit on the number of CDs you open, and no limit on the dollar amount. So, I have a couple of $25 CDs. But they’re earing about 1.75% more than the cash in my savings account right now.
I’ve stopped opening new CDs for a while, just ’cause the interest rate on the short-term CDs is the same as that for my savings accounts. And now that I have several dedicated savings accounts that I don’t dip into (and a Sonic Screwdriver Fund, that’s what other people would call a “Freedom Account”) I’m less likely to go spend-crazy.
Just… smack my hands if I try to purchase a Nintendo DS Lite before March, okay?
January 31st, 2008 at 2:18 pm
I know some people say keep your emergency fund completely liquid in case you need it immediately, however, I believe differently. In JD’s case he has (or plans to have) $10k. If he or his wife were to lose their job then they would need this money. But they wouldn’t need it all at once. You would need it as bills came due. So you could keep part of your emergency money (maybe 20-30%) in 6 month CDs. That way, by the time you get around to needing it (if you ever do), then it would have come due and you could use it w/o penalty.
My father actually uses a series of six, 6 month CDs. One matures each month. If he doesn’t need the money it is automatically rolled over to another 6 mo. CD. This way he has something available each month if needed.
Of course, everyone is different. Again, to use JD as an example, he is about to be self-employed. He’s probably a bit more at risk of needing his emergency fund than others (like a tenured teacher). In other words the amount of risk you have in your life would be a determining factor in just how liquid all of your emergency fund is.
January 31st, 2008 at 2:25 pm
We got a CD a couple weeks ago at our local CU. The rate was 4.5% for a year. I’ve never had a CD before and didn’t realize that a rate cut could affect the rate that quickly. Our Money Market savings is at about 2.3%.
January 31st, 2008 at 2:47 pm
Another vote here for ladders. With regular income coming in, I keep a spare month’s expenses in checking (or more if I know there’s a big expense coming up, like the new roof), and the rest in treasury bills. They pay less than CDs, but are also exempt from state and local taxes. They are incredibly easy to purchase through Treasury Direct, in 1-, 3-, and 6-month bills, $1K and up.
I switched to treasuries when I got annoyed that my bank wouldn’t let me close a money market without charging fees (then waiving them when I called to complain), and not wanting to keep shopping for the bestest of CD rates.
(Disclaimer: My credit union messed up my ladder by offering me a 7+% special rate last year, limited time offer.)
January 31st, 2008 at 2:50 pm
Is a CD the same thing as a GIC?
I keep somewhere between $3000-100000 in my savings account for emergencies and larger expenses. I don’t worry about ear-marking money, I just dump it all in the one account and take it out as needed. When my savings balance gets too high, I put it in something longer term.
I used to use ING GICs for this, but the rate of return is not that great. As they’ve matured I’ve moved my GICs into a bond fund with the same company that manages my RRSP and long-term investments. Historically, the return has been better than one-year GICs and instead of being locked in, you merely have to deal with fluctuations in the market. But it’s not so volatile that the money won’t be there when I want it (for a car or a down payment on a house).
January 31st, 2008 at 2:53 pm
Another thing to be aware of when using short term CDs for emergency money is that you don’t loose that much if you have to cash them in before their maturity. Be sure to ask what the penalty is for early withdrawal.
When I had less money than I do now I laddered some emergency money in CDs to get a little higher interest. I was pretty sure I wouldn’t need the money but not absolutely sure. As things happen when you are living on a small sum, my living expenses ended up being a little higher than I expected. Switching my son to a better day care was real important to me. So I went to the bank where I had CDs and said, “hey I need some of this money”. The banker very nicely sat down with me and figured out which CD I could cash with the least loss of interest. There was no loss of principal and at 4% interest, the penalty (I believe it was not all of the interest accrued but just some of it) was not that much either. Since this is the only time I needed the CD money for an emergency it was well worth the extra interest I got the rest of the time.
Even if something more catastrophic had happened, the loss wouldn’t have been that great.
January 31st, 2008 at 3:09 pm
I can understand the argument against CD’s and the early withdrawal penalties, but I look at it this way: It’s not a REAL emergency if it’s not worth forfeiting the interest. I keep a lot of my emergency money in CD’s because it keeps me honest and removes temptation. I can’t just “borrow” $50 here and $30 there when I come up short at the end of the month. And, in the event of a true emergency, I won’t care about forfeiting interest because it will be a true emergency. Make sense?
January 31st, 2008 at 3:12 pm
The difference in rates between a CD and a money market fund are really not great enough to want to have the money tied up for an extended period. Unless this is money that you have no need to utilize for a generous period of time why would you do it. The spreads used to be greater and it made more sense….I don’t see that today. There are a few places where you can get a really good interest rate on a money market account. Eloan and Countrywide come to mind.
January 31st, 2008 at 3:14 pm
re: CD ladders - some talked about setting them up to be available shortly before the end of a month, in case you needed the funds. This is a great idea but it actually doesn’t work very well in practice, at least for the shorter-term CDs. They may be marketed as 3 or 6 month CDs, but they are actually 90 or 180 days. So if you opened a 90 day CD on Jan. 1 this year, it’d come due on Mar. 30, and when renewed, the new date would be Jun 29, and so forth. It doesn’t take many cycles before your CDs are all coming due at odd days in the middle of the month. Still worth doing, just don’t expect that you can set it up so you’ll always have your funds available on a certain day of the month (i.e. the 23rd).
January 31st, 2008 at 3:36 pm
I must say that I am quite upset with INGs rate drop on savings accounts. I realize that other banks are doing this as well, just not quite as much as ING. That being said I did look into the CDs on INGs website. It appears that all of ING’s CD rates are 3.65% which is the exact same as their savings rate. Now why the hell would anyone in their right mind take out a CD and get locked into a 1,2, 5 year commitment when you can put your money into a savings account and have access to it. CDs generally do earn a higher rate but you sacrifice accessability. What is up with ING? Do they think their customers are that stupid?
January 31st, 2008 at 4:53 pm
@Dave: Well, as this post points out, the CD interest rate is fixed for the term of the CD, while the savings account rate can drop at any time.
January 31st, 2008 at 6:04 pm
@Dave,
I expect ING to be dropping their savings interest anytime up to 0.4% to match what the fed did. The CD rate will probably stay the same or drop a hair and that will be the difference in earnings between the two.
January 31st, 2008 at 6:47 pm
Working for a large bank, I’ve suggested that to several customers who still continue to keep large sums in a savings account. Most give me the the same response about how they’ll come in “next week” to set one up, yet I’ve seen the rates for our CDs drop every day or two since the fed cut interest rates. Gah! It’s so frustrating to see people with more money than they know what to do with not take simple advice because they’re more worried about me trying to “sell” them something.
If you want to make the most out of your money and can handle keeping it away for 3 to 6 months at a time, why not?? There’s even CDs out there that will keep your funds “semi-liquid” allowing to take money out at certain times without getting a penalty fee.
January 31st, 2008 at 6:47 pm
Wish I had locked in a higher rate sooner! I’m always concerned with the early cash-in fees associated with CDs, when I’m probably losing out more than that in a much lower interest rate in passbook savings accounts.
January 31st, 2008 at 6:59 pm
a money hack a friend taught me for her emergency savings, that you might consider:
Open three three-month CDs, each with a third of your emergency fund. Have each one roll over on the same day of the month, for three months in a row. That way you have your savings secure, earning a higher interest rate than a savings account, but still easier to get to than a longer term CD. I did this with my emergency savings at my credit union, and when I had to cash them out, I was only penalized on 3 months interest on 1/3 of my fund, rather than the entire amount. Make sense? It’s a bit of a psychological hack, but I found it made me a lot less likely to dip into the emergency fund than if it was just in a no-penalty-for-withdrawal savings account.
January 31st, 2008 at 7:01 pm
Frugal Dad:
What if the fees associated with CDs are lower than what a rate drop would have cost you? I’m willing to bet… CDs win.
January 31st, 2008 at 7:40 pm
It seems like a lot more micromanagement for not much (if any) more interest than you would get from a decent money market fund. It’s not FDIC insured, but MMF rates decline more slowly than bank savings accounts, just like CDs, precisely because their underlying holdings are CDs and other fixed-term debt instruments.
January 31st, 2008 at 7:54 pm
Erhm, doesn’t the CD rates drop with the fed rate as well? While it might have been smart to lock in a CD rate when the fed drops their rate, the opposite holds, when the fed raises their rate. If chasing a few extra basis points (compared to a savings account) my vote is on the money market fund as well.
February 1st, 2008 at 6:30 am
I opened an ING CD in Nov when I had about 12k in my ING direct savings account. When it matures I’ll have earned $236 in interest. That’s free money!
One word of caution- remember you can’t touch the money before maturation so make sure you have enough extra in your emergency fund. ING charges a 3 months interest penalty for early withdrawals, so if you withdrew too early (ie before 3 months) you could actually *lose* money and end up w/ less than you started with!
February 1st, 2008 at 7:52 am
one of the banks I work with has CDs to which you can add money — so if rates go down, I can put funds into an existing CD with a higher rate instead of the rate that is current. Also, if you watch for “specials,” you can often get some very nice rates even for short term funds, (one back here ran a special for its anniversary that was more than a point above rates at other banks at that time span..). CDs are more of a “snowflake” than a snowball in terms of savings, but they do add up over time…
February 1st, 2008 at 9:47 am
CDs work really well for me as an emergency fund - we have about 12K in CDs, plus a “liquid” emergency fund with on average $7000 in it - as other posters have said, I find myself using that fund to cover larger type expenses that come up here and there over the year, but the CDs keep me from touching the larger pot unless it was a TRUE emergency, and then it would be worth forfeiting a few months of interest.
I use a credit union, and they constantly have some sort of promotion to get a higher rate on one of their CDs - so my CD ladder isn’t exactly a ladder, but I have an assortment of three 12-18 month CDs. It doesn’t seem like much interest in the short term, but the key here is that I’ve basically left them alone and reinvested over the past few years, and it adds up - thus making my emergency fun that much stronger (necessary, as my living expenses get larger with kids).
February 1st, 2008 at 3:56 pm
I use CDs for my emergency fund as well. But unlike most here, I have them laddered in 1-5 YEAR CDs. So on the 5 yr CD I have a 5.3% interest rate. I don’t know what the penalty is, but I’m not planned to EVER have to use that money. If I do, I’ll eat the penalty and be glad for it.
The problem now is that I’m wondering what to do the next time a CD matures given that rates are so low. I don’t want to lock in 3% for 5 years…
February 2nd, 2008 at 1:17 pm
Has anyone invested in Intervest Bank before? They show up a lot with great rates but I never hear anything about them.
February 2nd, 2008 at 5:36 pm
Careful with those high-rate banks. Many are based offshore and aren’t regulated by US laws.
BTW: If you have many short term CDs that are automatically rolling over, you might just look into something like Vanguard Prime money market fund. They do the CD investing for you. There’s a downside risk, if rates fall, but CDs have a downside risk if rates rise too.
Prime MM is yielding around 4.3%.