No longer a need to ladder your emergency fund

June 27th, 2009 · 1 Comment

So earlier this week my wife and I opened up a new online savings account over at Ally bank, and I’ve gone back since to browse around Ally’s website trying to understand how to make the best use of their services and products.  The information about their “No Penalty CD” really caught my eye, as it seems almost too good to be true.

image: http://www.sxc.hu/profile/KillR-B

No longer locked into a CD term (image: http://www.sxc.hu/profile/KillR-B)

If you open up a “No Penalty CD”, Ally gives you a guaranteed, locked-in, fixed interest rate for a period of up to 9 months on money you put into the account.   That rate is currently a VERY competitive 2.15% APY for any deposited amount.  That is, there is no minimum and no tiering of rates.  But the big kicker is that, after an initial 6 day period after funding, you can withdraw all or part of your funds from the account without paying a penalty or fee of any kind!  They’ll give you your full balance plus any accrued interest at any point from +7 days to +270 days.  In effect, what Ally has done is given you extreme liquidity control at a very competitive, guaranteed interest rate.

I’m not kidding when I stress that Ally is giving you a competitive interest rate on this CD product.  For their own “Classic CD” account, as of today, the 9-month term only has a 1.75% APY.  A 6-month term is 1.85% APY.  And a 3-month term is 1.25% APY.  Just days ago I did a survey of 6-month CD rates and found the highest I could find to be only 1.90% APY.  The “No Penalty” CD is paying 0.25% higher than that.

There are a number of ways you could use this to your advantage.  The most obvious is that you can park a chunk of money in the account, and should interest rates rise, simply withdraw the money and move it to a new account at the higher interest rate.  You have no risk to being locked in and missing opportunities.  This is totally in your favor as you’re rate will not go down for 9 months, but you can “float” it up.

Another obvious use is for those just starting to, or in the middle of, building an emergency fund or income replacement fund.  For an emergency fund, it’s almost a no brainer to put the whole kit ‘n kaboodle in one of these accounts and let it earn maximum interest with no risk of loss (did I mention this was FDIC insured yet?)  And you can quickly get your money out in the event of an emergency.  For income replacement, you’re goal (obviously) is to ensure that you have replacement income coming in each month right?  But typically, to get a good interest rate you needed at least 6 months worth of that amount in order to ladder 6-month CDs so that one was maturing each month.  Yeah, you could find 3-month CDs but they aren’t a great deal IMO, and still you needed 3 months worth to avoid having gaps where you’d have nothing maturing.  Well, now you can put ALL of your income replacement in ONE account and not worry about paying penalties should you need to withdraw money each month.  And, again, should interest rates go up at all, you can easily move the whole fund to a new account at that higher rate.

You might be thinking you should still ladder an income replacement fund using multiple “No Penalty” CD accounts in order to hedge against interest rate changes, but keep in mind that you can simply close out any low interest rate accounts whenever you see a higher one available.   So there is no longer a need to make the effort of laddering.  Instead, you’re efforts should be spent periodically checking for rate changes, and doing one of three things.  First, if rates are lower, you’d certainly want to preserve any money in higher fixed rate accounts, so no action needs to be taken.  Second, if rates are the same, you should “roll over” any existing account(s) into a new one.  Why?  Because that gives you a new 9-month period of fixed rate interest, and thus increases your odds of not getting stuck with lower rates when you HAVE TO renew.  And third, if rates are higher, you’d always want to liquidate existing account(s) and roll them into a new “No Penalty” CD at the higher rate.

You might have noticed that I mentioned multiple accounts.  But wait, we weren’t laddering so why might you have multiple accounts?  Well, one thing you can’t do with a “No Penalty” CD is add money during the term of the CD.  Thus, if you’re trying to contribute each month to your emergency or income replacement fund, you’d need to be opening new CD accounts to do it. (Remember, there is no minimum balance to open one of these accounts! So you’d only use something else if it had a better rate.)  Just remember that it’s always in your favor to “roll over” your funds to a new “No Penalty” CD if you see it having higher rates than you’re currently earning on an account.

My wife and I will be putting our money where our mouth is on this one.  We’ve already opened one of these accounts with money we had transferred from FNBO Direct, which is actually one month’s worth of income replacement from when we didn’t renew our 6-month CD ladder.   And we’ve started the process of moving the other two months of income replacement via ACH transfer to Ally.  As soon as it’s available we’ll roll that into one new “No Penalty” CD, and if the current rate then is equal to what our existing account is getting, we’ll combine all three months worth into one new account.   The plan then is to check back once every two weeks or so to see if we should renew to capture a higher rate, or extend our 9 month rate lock.

Tags: Personal Finance · Savings

1 response so far ↓

  1. 1 Ally “No Penalty CD” rate drops to 2.05% APY | Geographic Independence // 2009.07.04 at 12:01 pm

    […] week ago I posted that we were starting a move of our emergency fund cash to Ally Bank in order to take advantage of their “No Penalty CD” product.  This will allow us to […]

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