The 411 On 911 Funds

The yield for the six-month CD is annualized, assuming reinvestment of principal and interest for a second six-month term.

There is often a minimum investment for CDs, ranging from $500 to $100,000 for a 90-day jumbo CD?, with $1,000 being a common minimum for many banks and savings and loans.

Unlike equities or most bonds, CDs are federally insured up to $100,000, which provides another measure of security that makes CDs a good way to build an emergency fund.

CDs are also very easy to purchase. Shopping around for the best deal is equally simple; most daily newspapers publish yields on CDs offered by area banks in their financial section. Picking the best CD is simply a matter of comparing the advertised yields.

THE PLAN IN MOTION

To set up an emergency fund using staggered CDs, first you must determine your average monthly expenses, including rent or mortgage, utilities, and credit cards or other debt payments. An emergency fund should have enough money to support you in the event of income loss or other crisis for at least three months, although setting up a six-month fund is advisable where possible.

For example, say your average monthly expenses are $3,000. In this case, you would need a minimum of $9,000 in order to set up a three-month emergency fund. A money market account is a good place to put the money you are saving toward your fund.

Once you have raised your minimum amount, divide that amount by three (since you are setting up a three-month emergency fund). For the first $3,000, purchase a CD with a one-month term. For the second $3,000, purchase a two-month CD, and for the third $3,000, purchase a CD that matures in three months. (See Figure 1.)

FIGURE 1: EMERGENCY FUNDS, AVAILABLE WHEN YOU NEED THEM. By purchasing three certificates of deposit (CDs) -- a one-month, a two-month, and a three-month -- and then rolling each CD over into a new three-month certificate, a part of your emergency money will be available, penalty-free, every month. Meanwhile, the interest earned on your CDs will help your emergency fund keep pace with inflation.

Now that you have purchased your CDs, all you have to do when each CD matures is roll it over in a 90-day CD. This will ensure you have $3,000 available each month in the event of unexpected or emergency expenses. Many banks and savings and loan institutions will be happy to roll over your CDs automatically, saving you the trouble of visiting the bank every month.

Having done that, not only do you have an emergency fund to take some of the worry out of your life, but the emergency fund is gaining more interest than you might get through other cash instruments. And as your income or living expenses change, don't forget to adjust your CDs as they come due each month, adding whatever amount is necessary to keep up with your changing needs.

There are, as you might imagine, variations on using staggered CDs as the foundation for an emergency fund; some investors, for example, might prefer a six-month emergency fund instead of a three-month fund. Such an emergency fund typically takes longer to deploy, but it's hard to beat the peace of mind that comes from having six months' worth of living expenses socked away in a federally insured account, earning interest of anywhere from 6.25% to 6.75%.

The most important thing to remember about emergency funds is that they do more than prepare you for the inevitable bumps in the road, such as loss of income. Emergency funds help clear the way for you to dedicate as much as you can toward fulfilling your investment dreams.