CDs Ladders for Emergency Savings… And Beyond!

Hey everyone. Exciting news today. We’ll be talking about CDs (Certificates of Deposit) and how I’m thinking about using them!

We haven’t owned any CDs for probably ten years. It was one of the first investments I made after graduating from college. Back then, you could get a one-year CD that paid over five percent! After the bottom fell out of the economy, the rates dropped like so many bricks, and they weren’t worth bothering with. Besides, we had more important things to put our money towards, like buying a house and investing for our retirement.

Today, we basically hold most of our financial assets in retirement accounts, whether it’s my 457 Plan, Marge’s traditional IRA, her 401(k), or our Roth IRAs. Then we have some taxable investments, which is the Vanguard Wellington Fund and some individually held stocks. Then there is the Cash Equivalents, which is the Vanguard Prime Money Market Mutual Fund (MMMF). And then there’s Lending Club.

The MMMF (Cash Equivalents) functions as our emergency fund. It includes 8 months of expenses, plus some savings for our rental property, our tenants’ security deposits, plus more to pay big bills like property taxes and home insurance. So there’s a lot of cash in there.

Our taxable investments  are the Wellington Fund and some individual stocks. They spin off some fun dividends and capital gains, and although that can be annoying at tax time, it’s not a ton more income that we have to report. I always look forward to the Wellington Fund’s year end distributions and call it our Christmas present.

I have started winding down our Lending Club investments. About a year ago, the default rate on my portfolio started going up. So for the last six months, I’ve been taking withdrawing our payments and putting them in Vanguard instead of reinvesting in more Lending Club loans.

CDs Instead of Stocks?

So I’ve got some cash in Vanguard to use, and I was hoping to use it to buy some stocks. The problem is, are there no good stocks to buy these days? I have a wishlist of companies, mostly your standard blue chip corporations. I don’t pay much attention to the stock market, but I know people have been saying it’s overpriced.

Here are some stocks I’d consider

Stock Price Dividend Yield
Bank of Nova Scotia (BNS) $58.14 3.93%
Proctor & Gamble (PG) $90.57 2.96%
Microsoft (MSFT) $64.98 2.40%
McDonald’s (MCD) $129.34 2.91%
Archer Daniels Midland (ADM) $45.58 2.81%
3M (MMM) $191.51 2.45%

We already own the first three, and I would add more shares of them. All of those dividend yields aren’t bad. But considering how highly those stocks are priced historically, I don’t know… Here’s a chart of the last 25 years in the S&P 500:

There’s the 90’s buildup, the 2000 crash, the 2008 crash, and the gains during the Obama years, and then the buildup after the Trump election. Does anyone else get nervous looking at that very last bit? I’m no Seeking Alpha nerd, so anyone who knows better, please speak up. To me, it seems like we’re bound for a downturn. Or a correction as they’re euphemistically called.

We’re still doing our usual retirement account investments, of course. As Vanguard says, you should stay the course and not react to market fluctuations. (This is usually followed by a silent “Praise Bogle.”) But I’m thinking of holding off on any more after-tax investments and putting that money into CDs instead.

Here’s Vanguard’s current CDs on offer:

Timeframe Rate
1 month 0.70%
3 months 0.90%
6 months 0.95%
9 months 1.00%
12 months 1.10%
18 months 1.50%
24 months 1.60%
36 months 1.85%
60 months 2.40%

Basically I’m thinking of parking some cash in a CD for 12 or 18 months, and once those mature, buying stock after a potential price correction? I guess this is a version of “playing the market,” which I’m not supposed to do (praise Bogle). But an 18 month CD pays 1.5%, which is almost as much as some of those stocks, and it doesn’t have the downturn risk.

The flipside is that CDs don’t have the upside potential of stocks. And though the stocks don’t pay huge dividends, the economy could keep improving and those prices could keep increasing. But like I said, most of our savings does go to stocks in our retirement accounts, so we would still catch any more upside there. What do you think using some CDs as temporary parking?

Laddered CDs for an Emergency Fund

While I was researching these CDs, I came across the concept of laddered CDs. Again, this is probably a concept I was aware of back when we did own CDs. Laddering CDs is a way to get CD returns in your emergency fund without having to potentially break a large CD and incur a penalty (usually some months’ worth of interest).

Bogleheads goes into depth on it, but basically to ladder CDs, you put the total amount you want invested across multiple CDs, so that one of them is always coming due within the next few months, or year at most.

So say you have $25,000 you wanted to invest. Vanguard’s 2.40% rate on their five-year CD is very appealing to you. Instead of investing it all for five years, you would split it up. You could put $5,000 into five different CDs, each lasting a different duration from one to five years. After one year, your first CD comes due. You re-invest that in a five-year CD. The next year, your two-year CD comes due, and you re-invest that in another five-year CD.

After five years, all of your money is invested at the five-year CD rate, yet it is broken up into discrete $5,000 blocks, so if you need it, you only need to break one CD (hopefully). And you are earning the difference the five-year CD rate (2.40%) instead of something like the one-year rate (1.10%).

I’m thinking of doing this for our emergency savings, but more conservatively than five years. I would max out at 18 months, and break it down into six CDs, maturing every three months. There is a big jump between the 12 month and 18 month CD rates, and they don’t increase much beyond that.

Vanguard’s Prime MMMF is paying more than it has over the past five years, but is still at 0.56% right now. With $25,000 invested, the MMMF pays $140 a year, but the 18 month CD pays $375. No one’s getting rich on that difference, but it seems like a risk-free way to make a few extra hundred dollars a year.

Have any thoughts on laddering CDs for an emergency fund?

2 Comments

  1. With my EF I have 1/2 in cash 1/2 in a CD ladder.

    • Norm

      April 4, 2017 at 6:51 am

      That’s what I was thinking of doing, DanO. Then I looked at Vanguard’s CD offerings, and you can only invest in $10,000 increments! Now I have to decide if it’s worth moving money around to a new bank.

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