Building an emergency fund is a crucial step toward achieving financial growth and stability. An emergency fund acts as a safety net for unexpected expenses such as medical bills, car repairs, or job loss.

While traditional savings accounts are a popular choice to build and maintain an emergency fund, there’s another option worth considering: certificates of deposit (CDs).

Let’s explore how to use CDs to build an emergency fund, including the concept of CD laddering, and address key questions to help you make an informed decision.

CDs can be a good part of an emergency fund strategy due to them having fixed interest rates and generally low risk. Let’s take a look at the pros and cons.

• Stability and security: When you invest in a CD, you agree to leave your money deposited for a specified term, ranging from as short as one month to several years. In return, the bank pays you a fixed interest rate. Because the rate is locked in, you don’t have to worry about market fluctuations affecting your returns.
• Higher interest rates: CDs typically offer higher interest rates than traditional savings accounts, allowing your emergency fund to grow more quickly.
• Fixed interest rates: In contrast to savings accounts, which typically have interest rates that can fluctuate over time, CDs generally have fixed interest rates, ensuring predictable returns.
• Low risk: CDs are generally considered to be a low risk investment.
• Savings discipline: The fixed term of a CD discourages withdrawals, potentially helping you maintain your emergency fund.

Liquidity issues: CDs are less liquid, potentially making it harder to access funds in emergencies without penalties.

Early withdrawal penalties: If you do need to withdraw funds before the CD matures, there are typically penalty fees, which can reduce your interest earnings or even your principal.

Limited access: CDs lock your money for a set term, limiting flexibility compared to regular savings accounts.

High-yield savings account: Consider keeping part of your emergency fund in a high-yield savings account for easy access without penalties.

No-penalty CDs: These CDs also offer fixed interest rates for fixed terms. In exchange for rates that are typically lower than those offered on high-yield CDs, no-penalty CDs typically allow for a fee-free cancellation in case you need to access funds prior to maturity.

Staggered CD ladder: Create a CD ladder by depositing equal amounts into CDs with staggered maturity dates to access funds periodically while earning higher interest. You can customize this strategy based on your specific needs.

Setting up a CD ladder effectively manages an emergency fund, providing both competitive interest rates and periodic access to your money. Before we start, let’s establish a basic understanding of CD ladders.

A CD ladder strategy involves dividing your investment evenly across multiple CDs with staggered maturity dates. This approach allows you to lock in a range of interest rates while always having some portion of your investment approaching liquidity.

• Liquidity: A CD ladder ensures that you have access to a portion of your emergency fund at regular intervals without incurring early withdrawal penalties.
• Higher return potential: By investing in longer-term CDs, you can take advantage of potentially higher interest rates, maximizing the growth of your emergency fund.
• Flexibility: As each CD matures, you have the option to either withdraw the funds if needed or reinvest them, providing flexibility in managing your savings.

1. Choose your number of rungs: Decide the number of CDs you want on your ladder. A typical CD ladder might have 3-5 rungs, but this can vary based on your personal preference and financial goals.
2. Select maturity terms: Select a range of CD terms that align with your financial goals. For example, if you create a five-rung ladder, you might select 1-year, 2-year, 3-year, 4-year, and 5-year CDs. Alternatively, a more conservative approach could be a three-rung ladder with CDs at 3-month, 6-month, 9-month, and 12-month terms. The idea is to have CDs maturing at regular intervals.
3. Divide your investment: Split your total investment amount equally among the CDs. For example, if you have $50,000 to invest and create a five-rung ladder, you could place $10,000 in each CD.
4. Stagger the maturity dates: Purchase the CDs at the same time but with maturity dates at regular intervals, whether that be every three months, every year, or your preferred interval. This way, CDs will mature regularly, giving you access to a portion of your funds.
5. Reinvest upon maturity: If you don’t need your funds as they mature, you could consider reinvesting the principal and interest into a new CD on the farthest “rung.” For example, when your 1-year CD matures, you would reinvest it into a 5-year CD if you started with a 5-year ladder.
6. Determine your total investment amount: Decide how much of your emergency fund you want to allocate to your CD ladder. It is also a good idea to keep a portion of your fund in a liquid account, like a high-yield savings account, where you can earn a competitive rate while maintaining immediate access.

Let’s say you have $50,000 to invest, and you want to set up a 4-rung CD ladder:

Step 1: Initial investment

• $10,000 in a 3-month CD
• $10,000 in a 6-month CD
• $10,000 in a 9-month CD
• $10,000 in a 12-month CD

Step 2: Maturity and reinvestment

• After three months: The 3-month CD matures. Reinvest it into a new 12-month CD.
• After six months: The 6-month CD matures. Reinvest it into a new 12-month CD.
• After nine months: The 9-month CD matures. Reinvest it into a new 12-month CD.
• After 12 months: The original 12-month CD matures. Reinvest into a new 12-month CD.

If you were to follow this, you would have a CD maturing three months, providing quarterly access to funds while continuing to earn predictable returns thanks to the fixed interest rates of CDs.

1. Emergency fund allocation

When deciding how much of your emergency fund to invest in CDs, consider your immediate liquidity needs. Financial experts generally recommend having three to six months’ worth of living expenses in an easily accessible account, like a high-yield savings account. Any additional funds can be allocated to a CD ladder to maximize interest earnings.

2. Bank policies and terms

It’s important to compare CD offerings from different banks, as interest rates, terms, and early withdrawal penalties can vary. Look for banks that offer favorable terms and minimal penalties to make the most of your CD ladder strategy. You can also consider a savings platform like Raisin, which allows you to open and manage a full suite of CDs and no-penalty CDs across a network of federally regulated banks and credit unions, all from a single login.

Building an emergency fund using CDs is a smart strategy for those seeking a balance between security, higher interest rates, and liquidity. By understanding the benefits and potential drawbacks and by implementing a CD ladder, you can effectively grow your emergency fund while ensuring access to your money when you need it most.

Explore Raisin’s exclusive network of federally regulated banks and credit unions to find, fund, and manage your CDs — all from a single no-fee login. Click below to view current offers and start building your emergency fund in just a few minutes.

The above article is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.