If you think interest rates are falling, put some of your savings into a CD. Since last August (2007), the Federal Reserve, haunted by the spectre of a slowing economy, had been hacking and slashing the Federal Funds and Discount rates. During that run, and until just recently, the prevailing attitude on Wall Street was that the Fed was going to continue cutting the rate until the threat of future inflation balanced out the threat of a recession. With this last twenty five basis point cut at the end of April, the prevailing attitude changed. Analysts now believe the Fed will stand pat and potentially even raise rates in the future.

During those rate cuts, all of the high interest online banks dropped their savings account interest rates dramatically. Since January of this year, the interest rate on E*Trade’s online savings account fell from 4.95% to 3.01% (only to increase, just recently, to 3.15%). ING Direct account holders saw their rates fall from 4.10% to their current rate of 3.00%. If you were able to purchase a CD at the prevailing higher yield online savings account rates for even a year, you’d be sitting pretty on those funds right now and that’s why CDs become popular during a falling interest rate environment.

This is where you say: “Jim, I’m not an idiot, I know that if the rates are going lower then I want to lock in good rates.” Yes, you are not an idiot but the point is I didn’t lock in any funds in CDs, except for my laddered emergency fund, because I didn’t recognize that I should have (or at least should have considered it). It wasn’t an error of judgment but one of ignorance.

Everyone knew rates were going to be cut but not everyone realized they should’ve considered putting a little bit away in certificates of deposit. (I can confidently say that because I know I didn’t) So, the next time you think rates are going to stagnate or fall, lock a little away in CDs.

Looks like ING Direct, which I lauded in my post about laddering your emergency fund, has now made it even easier to ladder you CDs by letting you open multiple CDs at multiple maturities all on one page.

If you have an account (if you don’t, you can open one through a referral link on ING Direct $25 new account bonus referral page and get $25 for a $250 deposit), the easiest thing for you to do is to go to their Orange CD laddering page. If you aren’t logged in, that link will take you to a login screen. After you log in, you’ll be presented with the normal account screen. Simple come back and click on the link again and it should take you to a screen that looks like this:

As you can see, the 6-, 9- and 12- month CDs are all at the 3.30% rate (not exactly the best, but you can’t beat the convenience and simplicity that ING Direct brings to the table) and you can open all three simply by entering values on one page.

Here are some recommendations or ideas I wanted to share:

• Name the CDs with the rate you’re getting (conver 3.30% to 330, because the naming system doesn’t allow special characters),
• Don’t label the period of the CD, such as 12 (or 6 or 9) month CD because that will change month and eventually every CD will be a 12 month CD,
• and, I wouldn’t write in the maturity date because that will be listed in your account snapshot (the “Account Type” will be Orange CD [maturity date]).

One final word of advice about ING Direct CDs, they’re default set to renew upon maturity. You’ll want to change that for your 6- and 9- month CDs because you will change them out for 12 month CDs once they mature. You can do this by clicking on the CD, clicking on the Account Maintenance link or icon, and change the Account Maturity to either closer or “Renew Principal Only to:” a 12 month CD (with interest rolling into the main account).

If anyone from ING is reading, any chance you guys could sort the Orange CDs in order of ascending maturity? That’d be nice!

Enjoy laddering!

There are plenty of articles out there discussing the importance of emergency funds and how to set one up, so this is not going to be one of those. I assume that you already understand all that good stuff (if not, check out these great articles in an MBN writing project). Here, I’ll discuss a strategy to maximize your emergency fund’s interest earnings so that you can lessen the pain of not having the funds in an investment account. The strategy is quite simple and works off the assumption that you are using the emergency fund to cover month to month expenses and not an enormous cost that is in the multiples of a month, though it can handle that too.

The Strategy

Ladder certificates of deposit so that you can maximize your interest earnings, minimize risk, and still have access to your funds when you need them. To ladder CDs, you purchase CDs for the amount of each month of savings but with different maturity periods so that one CD comes due each month. Let me us a real life example with ING Direct CDs (though I’d shop around for rates, I picked ING because they make opening a CD a cinch) to illustrate this. Also, for the sake of simplicity, let’s say you’ve saved up 13 months of savings of $13,000, which means 12 months will constantly be cycled into laddered CDs with one month sitting in a high yield online savings account.

Month 1: If you look at the ING Direct CDs, you’ll see that they offer 6 month, 9 month, and 12 month CDs (the rates are unimportant). Right now you need to find a CD that matures in 1 month, 2 months, 3 months, etc, but that will be impossible. The solution then is to buy one six month CD, one 9 month CD, and one 12 month CD. This sets you up to have three of your twelve months covered.
Month 2: Next month, you purchase another 6, 9, and 12 month CD. This sets you up to have half of the twelve months covered since the first set of 6-9-12 have now become 5-8-11. This puts your six CDs maturing in 5-6-8-9-11-12 months and your on-hand cash at seven months worth.
Month 3: You starting to see the pattern? Buying another 6-9-12 puts your total collection of 9 CDs at maturity dates of 4-5-6-7-8-9-10-11-12. At this point you also still have four months in cash sitting in your account.
Month 4: Now the pattern changes, since your CDs have now matured an additional year, you are looking at maturity rates of 3-4-5-6-7-8-9-10-11 months, but you can’t buy a CD of less than 3 months so you can only add an additional 12 month CD. This leaves you with three months of cash on hand and CDs maturing in 3-12 months.
Month 5: Add another 12 month CD to bring your full collection to 2-3-4-5-6-7-8-9-10-11-12, leaving you with 2 months of cash on hand.
Month 6: Add another 12 month CD and now you have a fully laddered 12 month CD structure in place, with 1-2-3-4-5-6-7-8-9-10-11-12 month maturity CDs! You still have one month of cash on hand.
Month 7: The first of your CDs has now matured and you’ll roll that into a new 12 month CD so that you have the full collection and still have a month’s worth of expenses in cash on hand. You will repeat this over and over and over …

Weaknesses

The primary weakness with this strategy is that you only have a month’s worth of expenses on hand. This lets you weather emergencies that cost less than a month’s expenses and those that have recurring costs, such as job loss. If you lose your job, you’re fine with this strategy because each month you’ll have access to another month’s worth of expenses as a CD matures. One mitigating factor about emergencies with a large cost, you can usually cancel your CD early and surrender the interest you would’ve earned, so laddering may be okay in that situation.

CDs with different maturity periods: What if your bank doesn’t offer 3 and 6 month periods? If you only have a 12 month period, then buy one year-long CD a month for a full year and you can the same laddering. The setup time will be longer and you surrender a bit of interest but there’s nothing you can do.

I hope you all were able to follow this explanation, it’s hard explaining something like that in text and I’m not an artist so it will have to do!

A bank is a bank is a bank is a bank right? So, why are there so many banks in the United States? Well, there are plenty of reasons but one of which is that each and every bank out there solves one problem or another for those people who hold accounts there. In the next few hundred words I’ll tell you which types of bank accounts you’ll need and where to go look for that type of account. By types of account I don’t mean savings, checking, money market, brokerage, retirement, or whatever account - I mean the purpose of the account. Once you identify the purpose of the account, it’s far easier to pick the right bank for you.

Daily Access Account

The daily access account is an account that you want conveniently located such that it’s easy for you to get your money very quickly. With the proliferation of automated teller machines (ATMs), it’s often just as good to have access to your bank’s ATM and not an actual full service branch. For me, my daily access account is a savings and checking account at Bank of America. I’ve heard of some horror stories from Bank of America (then again I’ve heard horror stories from every bank) but when it comes to ATMs, I don’t think anyone has them beat. Everywhere I go I see a Bank of America ATM and anytime I’ve needed money, a BoA ATM was just around the corner. What you need is a bank just like that in the places you go.

One important consideration with your daily access account is whether there are fees. Usually you can avoid fees by keeping a balance above a certain amount or by setting up a direct deposit. Since your daily access account’s interest rate will probably suck big time, you will want to keep as little as possible. You also want to pay exactly $0 in fees so pick this account wisely.

High Yield Savings Account

Let’s face it, right now CDs and bonds just don’t cut it. Everywhere you turn is another online bank that is offering you over 4.00% APY on your savings. While I’d be wary of picking any hole in the wall, ING Direct and Emigrant Direct have been doing the online thing for quite some time. Emigrant is also an online extension of their brick and mortar bank. Either way, your high yield savings account is where you will want to store the bulk of your regular savings. Emergency fund? Stick it in a high yield savings account.

One recommendation I have is that if you happen to be one of the lucky folks who has their Daily Access Account at Citibank, you’re in luck because they also have a high yield savings account that you can link directly to your regular Citibank account. Instead of waiting the 5-7 days to transfer funds from one bank to another, Citibank customers can do it instantaneously. If it were convenient I’d have a Citibank account.

International Account

If you do a lot of traveling, an international account is a must. I don’t know how many banks do this but one big one is HSBC. Many of my relatives hav HSBC accounts that they can get access to whenever they are in Taiwan and China or here in the good old US of A. From what I hear, the international account and the domestic account are held separately but you can transfer funds between the two relatively easily. Either way, I think that this is preferable to exchanging cash at the ripoff counter at the airport. (if you have a Capital One card, you can make international purchases without that pesky surcharge, Discover too but that’s less widely accepted)

Good Loan Terms Account

Nothing beats a credit union in this department. In fact, I’m a member of a credit union only because they generally have favorable loan terms! (I currently have exactly $6 in my account there) Credit unions are designed to work in favor of its members, so it will usually have the best loan terms compared to a commercial bank (they are designed to work in favor of its shareholders). Everyone can find a credit union they can join and everyone should join one because it will likely cost you nothing and you never know when you’ll need a loan.

Retirement Account

This can be at a bank or with a brokerage but having a retirement account is crucial. What you want to do is pick a bank or brokerage that has what you want with the lowest amount of fees. You want mutual funds? Life cycle / target retirement funds? Find the cheapest brokerage because those little percentage points are going to add up over the next few decades.

Brokerage Account

Everyone should have a brokerage account if they are saving their money and have more than they need in an emergency fund. This account can be tied into your retirement account but you will want one so you can start putting some of your hard earned money to work.

That’s it, those six bank account types cover essentially everything you need. (I hope! If I’m wrong or missed something, please let me know!)

Many people know that Certificates of Deposit (CDs) and Money Market Certificates (MMC) are one of the safest investment vehicles out there, but who wants to tie up their money all those years for the more attractive rates? The answer is no one. That’s why one of the “plans” that many financial advisers advocate is a laddered CD/MMC investment strategy where you purchase multiple certificates are different maturing dates so that you can lock in the best rates for your money. The net effect is after a few years, you own the best possible rates on your CDs that you could get.

Example: You have $5,000 to invest. In the above plan, simply invest in the following:
$1,000 in a 1 Year MMC at 3.00% APY
$1,000 in a 2 Year MMC at 3.50% APY
$1,000 in a 4 Year MMC at 4.25% APY
$1,000 in a 5 Year MMC at 5.00% APY
$1,000 in a 7 Year MMC at 5.15% APY
(These values are from The Pentagon Federal Credit Union, or PenFed, which are probably the best rates out there, as of 2/17/05)

What happens is in a year, your 1 Year MMC matures, so you want to invest in another 7 Year MMC with that original investment to get the best rates. After another year, your 2 Year MMC matures and you invest in yet another 7 Year MMC. This continues and you keep locking in the best prevailing rate at the time for the safest investment. And these CDs are federally insured up to $100,000 by the National Credit Union Administration (NCUA), which is the Federal Deposit Insurance Corporation (FDIC) for credit unions.

Want to try it? PenFed’s minimum purchase requirement is a mere $1,000 per MMC and the eligibility requirements are actually pretty lax. Basically if you or a family member is a member of the armed services (Active, Guard/Reserve, or Retired), then you’re definitely eligible. They list other eligibility methods. If none of those fit, join the National Military Family Association which is a great organization that I am a member of and only costs $20 a year. If you happen to use Geico as an insurer, the NMFA is a member organization so if you mentioned to Geico that you are a member of NMFA, they will knock 7-8% (I forget which) off your bill.

The tradeoff you’ll have to consider is that if you put it in a completely liquid ING Direct account, you’ll get 2.35%. If you go with Emigrant Direct, you’ll be getting 3.0%, and that’s totally liquid which the MMC’s are not. Read this post on where to park short term funds for a discussion of ING Direct and Emigrant Direct.