Where to Keep the Rainy-Day Fund
By: Jeff Brown

Year-end moves like rebalancing and selling money-losing investments for tax purposes can generate cash for a rainy-day fund. Next question: Where should that fund be kept?

Most people choose savings accounts, checking accounts or money markets. But a “laddered” series of certificates of deposit can help stretch the interest earnings.

CDs with maturities of two, four or five years don’t look like an obvious choice for holdings you may have to get at quickly. But, in a pinch, you could redeem a CD early and pay a penalty. It’s an especially attractive option if you don’t really think you’ll need the money anytime soon.

According to the BankingMyWay.com survey, the average money market account pays just 0.378%, while savings accounts average 0.221% and interest-bearing checking accounts just 0.134%.

With rates this low, the chief benefit of these accounts is safety from federal deposit insurance. You know you won’t lose any principal, and you can get at your money at a moment’s notice. Put your rainy-day funds into stocks or stock mutual funds and you could be forced to sell at a loss if they were in a rough patch when an emergency struck.

CDs, on the other hand, also provide federal insurance to protect principal and guarantee interest earnings, and they’re more generous than savings, checking and money market accounts. The only drawback is the penalty for withdrawing money before the CD matures. Typically, the penalty equals three months’ interest earnings on a CD with a two- to 18-month maturity, and six months’ interest on ones maturing in two or more years.

Average yields on 12-months CDs is 0.954%, according to the survey, while 24-month ones pay 1.398%, 48-month CDs pay 1.899% and 60-month CDs 2.218%

If you take out a five-year CD at about 2.2% and had to redeem it at the end of the first year, you’d earn 1.1% after giving up six months interest for a penalty. That’s still considerably more than you’d make with a savings, checking or money market account. In fact, it’s a tad more than you’d make with the average one-year CD.

By laddering a CD portfolio, you can have a mixture of short-term CDs, which won’t pay much but will mature quickly, and CDs with longer terms and better yields. A rainy-day fund sufficient for 12-months’ expenses, for example, might have three months worth in a savings, checking or money-market account, with the rest divided between six-, 24- and 60-month CDs. As CDs mature, money could be reinvested in new 60-month CDs.

Use the CD Ladder Calculator to figure the best mix of CDs, and use the shopping tool to track down market-beating deals.

For example, Discover Bank (Stock Quote: DFS) has a five-year CD yielding 3.3%, while AIG Bank (Stock Quote: AIG) has a one-year CD paying 1.83%, nearly double the national average. Also check any credit union you’re eligible to use, as credit unions often have especially generous CDs.

—For more ways to save, spend, invest and borrow, visit MainStreet.com.

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