The New York Times recently released a great series about consumer debt called The Debt Trap. One common thread in several of the videos is the devastating effect “emergencies” can have on your personal finances. A medical emergency, a job loss or cutback in hours, all of these emergencies were weathered, in the short term, with credit cards. In the long term, the credit cards charged high interest rates, piled on fees, and made it extremely difficult to recover. It’s like telling someone to pause for five minutes in the middle of a foot race so that you can strap on a 100 pound rucksack. You might catch up, but probably not.

This underscores the incredible importance of having an emergency fund. The economic climate is pretty rough right now. IndyMac went into conservatorship, Wachovia announced they were slashing 11,000 jobs, and the price of oil gyrates in the triple digits. The stock market is down and there’s a lot of red in those brokerage accounts. The last thing on most people’s minds is boosting that emergency fund. But now is the most important time to focus on your emergency fund.

In times of prosperity, it’s easier to weather emergencies without a plan. Bonuses are bigger, regular and OT hours are more plentiful, and there is less fear that you’ll lose your job. Boosting an emergency fund isn’t fun, but neither is crushing debt, bankruptcy, eviction, and the unfortunate feelings that come with it.

Feel your job is 100% safe? That’s great, but that’s actually not the most devastating emergency. About about half of all bankruptcies are the result of medical bills. You can’t predict the future, but you can prepare for it.

How To Start a Fund?

It’s very simple, get your check book, get your budget, and open an account at HSBC Direct (review), they are currently paying 3.50% APY. If online banks make you uncomfortable, open one at your local bank. A fund at 0% APY is better than no fund at all.

You’ll want to save at least six months of expenses, which you can tell from your budget (you budget right???). Try to accumulate that over [insert comfortable time period here]. The faster you do it, by sacrificing some discretionary spending now, the better.

Another option is to ladder your emergency fund in certificates of deposit. One place that makes it very easy is ING Direct but their current rates are all in the 3.30% APY to 3.00% APY range, less than HSBC Direct’s standard high yield savings account rate, so I would put it in HSBC Direct for now.

What are you waiting for?

(Photo: c.violette.run)

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!

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.