Difficult talks about a pleasurable finance topic (Part 2)

November 20th, 2008 · 2 Comments

In my last post, I mentioned how we had recently received a relatively large, lump sum, cash amount from a life insurance payout and how this caused “analysis paralysis” as we debated what to do with the money to maximize how it worked for us.  In the end, we realized there were two time periods we had to deal with.  In this post, I’ll talk about the first decision we made for the second of those periods, the “long term” plan.

Extending your reach with a CD ladder

Extending your reach with a CD ladder

If you read pretty much anything about personal finance, you’ll see that most everyone recommends establishing an emergency fund (EF) as the highest priority of choices you could make on what to do with income that exceeds your expenses.  And I’m not going to tell you anything different here.  So our first thought was to check on our existing EF and make sure it was funded appropriately.  Without too much trouble, we easily decided to add to the fund so that it would cover 6 months of missing income instead of just 4.  In the economic state we’re currently in, having this extra padding made us feel quite a bit more comfortable with our financial situation.

We also had a discussion about the purposes of the EF.  If you read many personal finance blogs and their user comments, you’ll read about people doing a lot of different things with their EF both in terms of how they use it and how they invest it — in my opinion, these differences are due to different income levels.   Because we’re in a situation where our normal income can handle most irregular expenses without us needing to treat it as an emergency, we agreed to continue to view our EF as income replacement should one of us lose our job.  For those really large irregular expenses (most likely unexpected medical bills,) our plan is to float the expense on a credit card until the next statement.  That gives us a time cushion so we can intelligently make decisions about where to pull the money from to pay those bills.

Given that decision, we then decided to check up on our decisions about where our EF was held and what kind of yield it was earning.  Our EF has been in a ING Direct Orange Savings account ever since we created it in 2001, and it’s yield at the time we were checking up on it was 2.75% APY.  While we discovered there were a number of online banks offering higher rates, reading blogged reviews of their policies and website designs didn’t really give us the warm fuzzies.  Pretty much simultaneously as doing that research, we talked to a friend who suggested that since we now had 6 months of lost income in our EF we could setup a CD ladder using 6 month CDs and never have to pay an early withdrawl penalty if we actually had to use the money (again, we’re talking about using it for income replacement and not irregular expenses.)  At the time, ING’s 6-month CD was paying a 3.5% APY versus the savings APY of 2.75%.  This CD yield was almost as high as the savings yield at almost all of the alternative online banks which made it a no-brainer to go with the comfortable ING web-site and begin to establish our ladder.

For anyone looking to do the same thing, I should point out that while ING Direct offers a handy web-page meant for creating a CD ladder, that page is focused on a multi-year ladder.  Not the 6-month ladder we’re trying to establish.   Instead, you’ll have to fallback on opening your first set of 6-month CDs yourself, one every month.   Set each one up to automatically roll-over into another 6 month CD and you’re pretty much done unless you want to actually use the money, or add to it at each renewal.  We put reminders on our calendar for the same date each month so that we don’t forget to open a new CD for each of the next 6 months.

As of today, we’re about to fund our second CD in the 6 month ladder so I just checked on the current yield of ING’s 6-month CD.  The news isn’t ideal as the yield is now down to a 3.00% APY.  My first response to this was a bit of disappoint as this means the current yield spread between the CD and the savings account is only 25 basis points.   But then I realized that with all the interest rate drops going on everywhere, the yield on the savings account will probably drop soon.   At least the CD will lock in the 3.00% APY for 6 months.   So its full-steam ahead for us on the CD ladder.

Tags: Personal Finance · Savings

2 responses so far ↓

  1. 1 TJ // 2008.11.20 at 10:45 pm

    We have a similar arrangement.

    One thing to keep in mind is that access to the money in the CDs is limited. In our case there’s a 7-day period after each CD matures when we can add or subtract money without penalty. Not a big deal in your situation but important to keep in mind if you aren’t able to get through those other 3 weeks without the EF.

  2. 2 davmp // 2008.11.21 at 6:46 am

    TJ: You were one of those who gave us the push to look into doing a CD ladder in the first place. Thanks for the tip!

    In regards to the note about limited access, the fact that we treat our EF as income replacement instead of cash to meet irregular expenses is what enables the limited access to be relatively inconsequential, but I still should have pointed it out for those who do need it for the latter. Thanks for bringing it up.

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