CD Laddering: The “Frugal” Way to Build an Emergency Fund

The importance of a fully funded emergency fund can’t be overstated. A rainy day fund acts as a safety net when unexpected expenses arise, and it gives you freedom from living paycheck to paycheck. The problem with most emergency funds, however, is that they are stuck in low interest bearing bank accounts. While there are high interest savings accounts, “high interest” today means a miserly 1% to 2%, as this list of accounts on Dough Roller shows.

If frugal spending is spending less, then frugal saving is saving more with the money you have.

And that brings us to CD laddering. While a certificate of deposit is a great way to build an emergency fund, there’s one big downside — penalties for early withdrawal. One way around this is to put your money in short-term CDs, but then the interest rate you get is really low. And while long-term CDs (3 to 5 years) pay higher interest, we’re back to the early withdrawal penalty problem.

CD laddering can solve this problem, and it’s really simple to implement. The idea is to spread your emergency fund savings over several different CDs with high yield rates. So rather than putting all of your savings in a 5-year CD, put 20% in a 1-year CD, 20% in a 2-year CD, 20% in a 3-year CD and so on up to 5 years. When the 1-year CD matures, roll it over into a 5-year CD, and continue this approach each year. Eventually, your entire emergency fund will be in 5-year high yield CDs, with one CD maturing every 12 months. With this approach, you’ll get the benefit of the higher 5-year CD interest rate, but also have penalty free access to some of your money every 12 months.

One objection to this approach is that 12 months is still a long time to wait for your money. Fortunately, there are several creative ways to deal with this problem.

  • The first is to ignore it! True, you risk paying a penalty for early withdrawal, but this may be a risk you’re willing to take for higher rates.
  • A second option is to start with a 3 or 6-month CD, rather than a 12-month CD. Most banks also offer 18-month and 30-month CDs, so you have a lot of flexibility and can set up a CD ladder with CDs that mature every 3 to 6 months.
  • The third solution is a no-penalty CD. As the name suggests, there is no early withdrawal penalty if you take you money out early from a no-penalty certificate of deposit. Ally Bank offers a no-penalty 9-month CD that pays a competitive rate. You can use this CD for 20% of your emergency fund rather than a 1-year CD. With this approach, you always have access to some portion of your money without a penalty. And of course, you can always decide to keep more than 20% of you emergency fund in a no-penalty CD.

Whatever options and combinations you choose, a CD ladder can be a great way to maximize the return on your emergency fund.

8 thoughts on “CD Laddering: The “Frugal” Way to Build an Emergency Fund”

  1. the best laddering scheme it seems, is to split up capitol into 12 parts, buying a 60 month (5 year) CD every 5 months.
    would welcome input on this concept.

  2. Yeah, aren’t interest rates sorry these days? I am old enough to remember the early 80’s, when I got 11% on a 2-year, $2000 CD! I wish I’d put the money away for a longer term, but I was nervous: just out of school, paying student loans, buying a business wardrobe, etc., and didn’t have much money to put away. If your readers work at companies with a credit union, check out their CD rates: mine just announced a 3% rate, which is much better than the banks around here! I’m going to see how much I can put in for that rate, which I haven’t seen in a couple of years. By the way, if your bank fails, and another bank takes it over, THE NEW BANK MIGHT CHANGE YOUR CD RATE, EVEN THOUGH IT HASN’T COME DUE!!! I couldn’t believe it, but it happened to me. I had a CD earning about 4.5%; when the other bank took over, they changed it to about 2.2%. I kid you not. This was a large account too (a 401K rolled over to an IRA when I left a job), about $60K, so the loss is not trivial. Grrr!

  3. I guess if you really are worried about being able to access your money you could keep 20% of your EF in a liquid savings account and then step up the CD ladder from there. Great plan though.

  4. Laddering is a great concept and can be a great way to also provide income during Retirement. CD’s are one option, but it can be done with any fixed income asset class including Corporate and Municipal Bonds

  5. BOA offers a no-risk CD. It limits the number/frequency of withdrawls but you do have access to your money without loosing all the interest.

  6. Highly recommened!
    I try to get the most interest at the shortest interval.
    Mine at the moment are 3 years, mostly staggered at 6 month intervals.
    However, now that I have a HELOC with 80% of the assessed value of my home available at the click of a button (no mortgage), I will be using that first, and then taking the CD out when it matures to “pay back” the Heloc loan if need be.

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