Should You Move Your Emergency Fund Into a CD to Capture a High APY?

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CDs have eye-watering interest rates that may entice you to lock away emergency savings. Read on to learn why this might be risky. 

The Fed’s relentless interest rate hiking campaign may have broken some banks, stirred up the stock market, and made borrowing money more expensive. But for those who like fixed income, the Fed has inadvertently made certificates of deposit (CDs) cool again — at least, for the time being.

The best CD rates still continue to hover between 4.25% and 5% for both short and long terms, just slightly below the new federal funds rate range of 5% and 5.25%. For those who have a wad of cash set aside for emergencies, these high APYs can be enticing. After all, it’s been more than 15 years since savers have seen CD rates this high. What’s the harm of locking your money in a CD with a short term, like six months, if it means earning more for future emergencies?

It’s risky, and it might lead to forfeiting some of the interest your money is earning. Let’s look at why it might not be the best decision to lock your emergency savings in a CD, as well as some less risky options.

Why a CD isn’t the best place for your emergency savings

CDs aren’t great places to store three to six months of emergency savings because they’re not designed to be flexible. When you take out a CD, you agree to lock a sum of money for a specific amount of time. If you decide to cash out early, your CD provider will penalize you, usually in forfeited interest.

For example, a 12-month CD may have a withdrawal penalty equal to 90 days of accrued interest. So if you deposit $20,000 in a CD with a 5% APY, you might have to pay roughly $246 to cash out early (assuming your bank assesses interest on a daily basis). In contrast, you would earn $1,000 in interest if you kept your money in the CD for the full term.

What stings even more is that many banks charge the full 90 days of interest (or however long your penalty period is) even if you cash out earlier than 90 days. Yes, that means your bank can shave money off your principal if you cash out too early.

So, returning to my example above, if you cashed out after 60 days, you would have earned only $164 in interest. Your bank may still charge the full $264, which is the interest you earned plus $100 off your principal. You’re left with $19,900, plus the opportunity cost of not depositing your money in a more flexible account.

Other options for an emergency fund

Even if CDs aren’t the best place for your emergency fund, you can still take advantage of today’s high APYs. Here are some safer accounts to park your cash.

Money market accounts: Money market accounts are excellent places for your emergency fund. They’re extremely flexible and let you withdraw funds with checks or a debit card. Many of the best money market accounts have APYs that are only slightly lower than high-yielding CDs.High-yield savings account: The APYs on many high-yield savings accounts are super attractive and can be on par with CDs. You might have to meet some requirements to open one — such as having a minimum balance — and your withdrawals are usually limited to six per month without penalty. But these savings accounts can offer more flexibility than CDs, without sacrificing high interest rates.No-penalty CDs: Yes, there are CDs that won’t penalize you for taking early withdrawals. These no-penalty CDs often come with lower interest rates than other types and typically don’t have partial withdrawals. In other words, if you need to withdraw money early for an emergency, you’ll probably have to clear out your account and close it.

Your emergency savings are too important to lock up for any specific period. This money requires easy access; otherwise, you defeat the purpose of having an emergency fund at all, which is to protect yourself financially when the unexpected strikes.

Besides, with so many other savings vehicles — like money market and high-yield savings accounts — you can still earn high interest without locking up your cash. It might mean earning a little less than a CD, but it can be worth it for the added safety.

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