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Feb 21, 2018
9:49:48am
Biyamiti All-American
Another alternative strategy for the rainy day fund
would be to put a portion of the funds in a 5 year CD instead of a money market.

Assume a 5 year CD yields 3% and has a penalty of 180 days interest for early withdrawal. Also assume a money market yields 1.5%. Assuming a $10,000 investment the penalty for early withdrawal on the CD is $150.

In 1 year the money market would earn $150. In 1 year the CD would earn $300, but you what pay a $150 penalty, so would net $150 if you had to withdraw in 1 year. This is your break-even point.

All scenarios less than 1 year the money market performs better. All scenarios in which your withdrawal occurs after 1 year, the CD strategy performs better.

Worst case scenario is you need the money tomorrow and pay a $150 penalty and earn no interest. Best case scenario you don't need the money in the next 5 years and are $600 better off with the CD (which is net of the penalty).

Assuming it's unlikely you'll need money in the next year, this strategy performs better than putting funds in a money market.

This of course assumes rates stay flat - which is unlikely at this time as the Fed is likely to continue to hike rates, which should lead to rising rates in money market accounts. However, I think it is unlikely that rates rise fast enough that the money market performs better, assuming you can get past the 1 year break-even point.

If the risk of withdrawing within a year is too great, leave funds in a money market. If not, the CD strategy is likely to perform better but has limited downside compared to more risky alternatives such as equities or bond funds.
Biyamiti
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Biyamiti
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