Should I mount a CD ladder to build savings?

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Don Taylor
Dear Dr. Don,
I am embarking on a simple savings plan as I climb out of debt. I recently got an extra job that will bring in about $250 per month. I was thinking about beginning to build a certificate of deposit ladder and each month buying another CD. Is this a good strategy, or should I simply put the money into a savings account? I am currently on a budget that will have me debt-free in about 24 months. I have no emergency savings.

Thanks,
-- Veronica Victor

Dear Veronica,
Congratulations on taking the debt bull by the horns and designing a two-year plan to get you debt-free. Taking on an extra job to increase your monthly income is also a great step for people who have the time and inclination to do that.

I think you should focus on building an emergency savings fund first before looking to invest. The downside to using CDs in an emergency savings fund is you'd have to pay an interest penalty for early withdrawal should you need to cash in a CD for a financial emergency. As long as you understand that, however, there's something to be said for combining the two goals and building a CD ladder with your emergency savings fund.

I initially liked your idea of investing in a $250 CD every month. If you picked a five-year maturity as your investment horizon, then you'd buy a new five-year CD for $250 every month.

But after 60 months, you'd have a five-year ladder with 60 rungs. That's where I start to have a problem. Do you really want 60 deposit accounts to hold an investment of $15,000?

How about letting the $250 paychecks accumulate for six months in a high-yield savings or money market account, and then invest in the five-year CD? You'll gain the benefit of having some liquid savings available for emergencies, and you'll only wind up with 10 CDs after five years instead of 60.

I typically recommend that people have three to six months' worth of living expenses set aside in an emergency savings fund. Once you reach that target with your CD ladder, it's time to look elsewhere for investment opportunities.

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