This financial move requires a bit of work, but it might be the best way to maximize interest on your emergency fund during times of high inflation: It’s called a CD ladder—a series of overlapping certificates of deposits that expire at different times so you have a steady stream of cash that still takes advantage of long-term interest rates. Here’s how it works.
What’s a certificate of deposit?
CDs are actually quite simple: You give a lump sum of money to a bank in exchange for not making withdrawal for a fixed term, anywhere between three months and five years. In exchange, you can lock in an annual interest rate for that term (the longer the term, the better the rate).
The advantage to CDs is that they’re considered a safe way to stash your money, and they typically earn more interest than checking, savings, and money market accounts (currently, it’s closer to 1% APY, compared to 0.50% APY). The downside to CDs is that withdrawing the money early incurs fees that will essentially wipe out any interest you’ve accrued.
Okay, but what’s a CD Ladder?
A CD ladder is a savings strategy whereby you put money into multiple long-term CDs with staggered expiry dates so that you have a steady flow of cash on hand at regular intervals without needing to withdraw money early. For example, with $10,000, a CD ladder will look like this:
$2,000 in a one-year CD
$2,000 in a two-year CD
$2,000 in a three-year CD
$2,000 in a four-year CD
$2,000 in a five-year CD
Then, when the CDs mature, you put that money into a five-year CD, as follows:
$2,000 (plus one year of interest) in a five-year CD
$2,000 (plus two years of interest) in a five-year CD
$2,000 (plus three years of interest) in a five-year CD
$2,000 (plus four years of interest) in a five-year CD
$2,000 (plus five years of interest) in a five-year CD
By doing this, you’re maximizing long-term interest rates, while giving yourself some flexibility to use the cash if you need it, as a CD will expire every year. (For the best CD interest rates in September, check out this Bankrate post).
There is some risk in this, as you won’t have all of your cash available, unless you want to cash out early and lose interest on the principal. For this reason, you might only put part of your emergency fund into a CD ladder.
Why wouldn’t I just put that money into stocks?
A couple of reasons: risk and liquidity. There’s always a risk you could lose your money by investing in stocks, and it might not always be easy to sell your stocks at a favorable rate when you’re in an emergency. Plus, you always want a bit of cash on hand, aside from your investments.
Bottom line
While a CD is less liquid than a savings account (which allows for penalty-free withdrawals), it will earn more interest. Of course, interest rates are very low right now, so it might only add a few hundred bucks to your cash reserves, but it’s better than nothing. You can play around with this CD ladder calculator to see if it’s worthwhile for you.