Put Your Savings on Steroids with Certificates of Deposit

I really have to start looking at CDs because I use paypal to hold my emergency funds, and it used to be above 5% interest, but now it’s almost below 2%.

This is a perfect and very timely post. Thanks J.D!

“In fact, many (most?) banks penalize the interest amount, even if it isn’t earned (meaning you could lose part of your principle if you close your CD early).”

Dang. I’m going to avoid CDs at all costs. I would hate to lose my principles.

Right now, dollarsavingsdirect.com is offering 4% if you open with $1000 (but there’s no minimum balance). It’s the same bank as emigrantdirect.com, so I’m not sure exactly why the latter is only offering 2.75%. In any event I now have accounts at both and I’ve transferred to dollarsavingsdirect.com to earn as-good-as-CD rates with complete liquidity.

I have to agree with Don. I have a dollar savings direct account and wouldn’t dream of losing the liquidity for a lower interest rate. Even with the recent changes in prime, the rate has stayed at 4%. JD, I’m amazed that you haven’t made a post about this new product since the rate chasing thread had such a response.

I’ve been using CD laddering for my emergency fund for years. I have 6 6-month CD’s, maturing sequentially over 6 months and auto-renewing.

The beauty of this is that I only have access to one months worth of my emergency funds at a time, preventing me (or at least making me think about it) from going through the fund too quickly.

Luckily I have not yet had to tap the funds and my fund has automatically increased with my cost of living (for my monthly bills at least).

But what happens if interest rates go up again? Just two years ago, high-yield savings accounts were garnering 5+ and HSBC was even offering 6% for a few months!
At that time, the CD were all barely above 4%.
If this happens, does it makes sense to withdraw from the CD and put it back into the savings account?

I’ve got two $10,000 CDs I set up with 6 month terms. They’ve each rolled over once. I’ve “earned” $600 just by leaving it alone. It really couldn’t be easier. And because I’m a procrastinator, I’m pretty much guaranteed to miss the deadline for withdrawing the money (unless I really need it; that’ll keep it in the forefront of my mind) and it’ll roll over automatically.

I love the idea of the 12 CDs ladder!

CD laddering is a great way to go, but I disagree with sticking with one bank for ease. With internet banking, it is easy to set up and track CDs at an array of banks. I have a 5 year ladders at 6 month increments. All 10 CDs started at my credit union. Now I have CDs at 8 banks based on who had the highest rate at the time a given CD expired. Bankrate.com lists the best rates. While ING offers 4.25%, GMAC offers 5.15% for the same time duration. Both are FDIC insured, and GMAC only requires $500. This is not a plug for GMAC but rather an endorsement to go with the highest rate you can get from an FDIC insured institution.

Like others, we have 6 staggered 6 month CDs, each with enough to get through 1 month with no other income (e.g. in case we lose a job). But we _also_ have, not in CDs, enough to cover the non-expected/non-regular portion of our emergency fund. We’ve decide this is an important part also. We decide on a peak amount that we might need from our emergency fund, then put that much minus the monthly amount (which would come from the monthly CD) into this extra account. Now we just hope we don’t have a peak emergency _and_ lose a job, but we’re working towards that.
Also, we’re working towards moving those 6 6-monthers up to 12 1yr CDs, but that takes time.

In Canada we do have CDs, their maximum term is less than one year and they usually have a higher minimum than GICs (e.g. $5000 for a CD and $1000 for a GIC).

Many of our local banks do offer a rate ‘bonus’ if you have other business with them, or are willing to move other business to them. I have seen the bonus as high as 0.75%, not bad if you are flexible with your record keeping.

Note: CD in Canada is actually called “Term deposit”.
GIC is more of an investment.

This may seem like common sense to most of you but I recently opened a CD with $10 under the assumption that I could continually add dollars to it over time like I do my savings account. Not the case. It’s a one time deposit, then you basically don’t touch it until it matures. Bad me for not reading first.

JD, great post. We have four CDs with ING. They come up every three months. We took a portion of our e fund and put it into CDs. We haven’t touched our e fund but one time in the past two years that we’ve had it. If the worst happened, we could liquidate our CDs and take the penalty. ING CDs are great products and easy to use.

I want to win one too!

@sammy: “The interest rates you quote on CD’s for example–the rate of inflation is higher. The interest you earn is taxable, too.
What’s a saver to do?”

Sammy, there are savings that are there for when you’d need money soon and there are investments where you could lose money but may get higher return. Still there are some safer options:

If you want some protection against inflation yet don’t want to lose money, you can consider government tax-protected securities such as I bonds that determine rate based on fixed portion (current 0 – ouch) and a portion based on inflation — but you are only to invest $5000 a year. There are also TIPs that pay a small interest and increase your principal by the inflation amount every year. You can find out about all of those if you go to http://www.treasurydirect.gov. Government bonds are safer than CDs as they have full tax power of the US government behind them.

If you can stand (a little) risk but not as much as in the stock market, you can look into bonds – both municipal and corporate. Because of current credit crunch, there are some attractive yields there. Just last week I bought $5000 worth of 10-year old AAA-rated municipal bond with a tax-free YTM (yield-to-maturity i.e. yearly yield that takes into consideration today’s cost of the bond) of 5.36%. This yield is gone now – my bond is already up – but there are still some 5.016% AA-rated bonds. This is tax-free; both federal and state if you buy your state’s bonds. If you keep to AA and AAA bonds, the chance of default is very low.

Corporate bonds are riskier, so you have to investigate the company. The yields now are very attractive, though, with some good companies paying 9.7% and 10.3% (e.g. American Express, Prudential, Goldman Sacks); Verizon is paying over 8%. If the company goes bankrupt, you lose your money, so there is some risk. I just transferred another $5000 into my brokerage account, and I am thinking of buying one of these bonds.

Now, bond interest is usually is simple interest simply paid to you as income twice a year. So you don’t get advantage of compounding, but then you can take the interest bonds pay you and invest it in something else.

Another thing. If you call bonds to maturity, you get your principal back (unless bond issuer declares bankruptcy); the interest gets paid to you as income usually twice a year. In the meantime, however, the value of the bonds fluctuate. Usually, the value goes up when the interest rates go down and vice-versa. So if at some point you decide you don’t want to hold to maturity, you can resell at whatever the value is. For example, if you need the money, or if the bond resale value goes up and you want to take advantage of it. BTW – the $5000 municipal bond I bought, I paid $4995 for, but now a week later it’s resale value is $5250 (which makes resulting yield-to-maturity smaller since the bond pays fixed interest amount; it was larger relative to $4995 but is smaller relative to $5250); if it goes up more I might even consider selling it. Of course, then I’d have to pay taxes on capital gains.

If you want money soon, you can build a bond ladder – some bonds that mature next year, some that mature some years in future. Again, if you need your money you can always sell the bond, but then you get whatever value it is selling for at the time which could be above or below you got it for.

One thing about Savings bonds for emergency fund that might come up (it did once for me)… Most people don’t declare their interest income every year on their taxes, they just defer it until redemption.

What that means is if you have an emergency that you cash your savings bonds to pay for, you’ll owe extra tax come tax time. Now depending on the situation that might not be so bad. If you lose your job, you’re paying less tax anyway. But if it is just money for an unexpected expense, that might be different.

I still have a significant portion of my emergency fund in savings bonds, but I also keep a chunk in online savings accounts now so I pay part of my tax “as I go.” That is the part I would access first for emergencies.

In my experience, the rate resets. These details are usually provided you, via mail/email, a few weeks prior to the CD’s expiration. With my credit union, you have an option at the outset for either renewal at current rates or deposit into your checking/savings account. The devil is in the details, hopefully provided at sign-up. If not, consider another institution…

Ron, Jeremy is right, the rate resets. You can’t hold on to a high rate forever. This is why you want to make sure that if you don’t want a CD at that rate, you don’t let the CD roll over. This is especially important since CDs can become much more attractive or much worse investments at any given time based on rate fluctuations.

My emergency fund is in a series of laddered CDs at INGDirect. But I didn’t open them all at once, I started out every paycheck opening a new 6 month CD with $50. INGDirect has no minimum deposit for CDs, and frankly, when I started this scheme, I was lucky to be able to scrape up $50 a paycheck for a CD.

A year and a $700 new computer later, I went from a negative checking account balance to 17 CDs totaling about $1600. Voila, I’m a *saver*!

You can also check out risk-free CDs, which some banks offer (I have one at Bank of America). With the risk-free CD, you pay no penalty for withdrawing funds early (with funds available within 7 days)…so a tad less liquid than a savings account, but still much better than having to pay the penalty with a normal CD.

It has a slightly lower interest rate due to the fact that it’s risk free (but still better than a savings account), so I have $5000 in the risk free for emergencies and the rest of my savings in regular CDs. To be honest, I am probably being somewhat paranoid about putting away $5000 in emergency money, but I’d rather be safe than sorry.

I have to wonder about people using a CD as an emergency fund. I fear people may have lost sight of the purpose of an emergency fund — either that, or they’re OK taking an early withdrawal penalty in the case of an emergency.

Keep in mind that an emergency fund is there for *emergencies* — what if you crash your car and need a new one, or burn down your kitchen, or get sick and have thousands of dollars in medical bills that aren’t covered by insurance, or lose your job? These are the reasons you have an emergency fund, presumably because you’ll need to be able to get at money quickly if these things happen. That’s something you can’t do with CDs (unless you accept the penalty).

I recently realized that my $10,000 emergency fund was overkill. It had become a generic savings account, and although I’ve withdrawn from it several times for genuine emergencies, I’ve never had to withdraw more than about $1000. I realized that the chance of me needing more than $5000 in an emergency is exceedingly unlikely (I’ve never spent $5000 on a single thing or event in my life except cars), so I reduced my emergency fund to $5000 and put the remainder towards other goals.

Lisa: the APY is already calculated for you, but yes it does compound. When a year is up, the APY will be whatever it is.

Eden: why not do both? If you don’t need all your money to be liquid, why not get a little bit extra on some of it? It’s not that hard to do with the online services.

agreeing with angelo, the higher rates of cds provide a little bit more, so why not?

also the idea of laddering, in part, is to avoid market timing. like stocks, it is hard to predict interest rates. in 2002, you cd from 1998 locked in at 4.25% for a decade, looked pretty swell.

I have been wondering for a while exactly how CDs work. I have about $10k in ING Direct savings for no reason, and thanks to this post, I’m considering looking into a CD. Thanks for the post!

What a timely article! I just got done setting up a CD ladder from my ING Orange account, they have a real cool page to do that all at one time. Figured I better get on the ball before rates go down even lower.