I Keep Part of My Emergency Fund in a CD. Here's Why

It's important to have money set aside for financial emergencies, whether it's car repairs, medical bills, or a period of unemployment. And you'll generally hear that your emergency fund should contain enough cash to cover a minimum of three months of essential living costs. The logic there is that if you were to lose your job, that sum could help you pay your bills while looking for work so you don't land in debt. 

As a general rule, the best place to keep your emergency fund is none other than a savings account. And while I happen to keep the bulk of my emergency fund in a regular savings account, I do have a portion stashed away in a certificate of deposit (CD). Here's why that works for me -- even though it may not be the best idea for the typical saver.

Why I have more wiggle room with my savings

The reason people are advised to keep their emergency cash in a regular savings account is simple. With a regular savings account, you can take withdrawals whenever you want, and without any sort of penalty.

CDs work differently. You'll commonly snag a higher interest rate on your money with a CD versus a savings account. But in exchange, you're committing to keeping your money in that CD until it matures. That could happen in six months, a year, or longer -- it depends on the term of your CD.

If you end up having to remove money from your CD to deal with an emergency expense, you'll be assessed a penalty. Now, that penalty varies by bank, but at Capital One, for example, you're looking at a penalty of three months' worth of interest for cashing out a CD with a term of 12 months or less. Since you might have to raid your emergency fund at any time, you risk facing a penalty when you keep that cash in a CD.

But the reason I have part of my emergency fund in a CD is simple -- I probably have a larger emergency fund than most people. A big reason for this is that I'm self-employed with a variable income. If my clients were to pull my work on me out of the blue, I'd need to build up a whole new base. And since I'm not eligible for unemployment as a self-employed worker, I need extra backup in savings form.

Also, many people I know have the option to turn to their parents for financial support in a dire situation. I don't have that option. So I need to protect myself by keeping a 12-month emergency fund on hand.

Because I have 12 months' worth of bills in savings, though, I can tie some of that cash up in a six-month CD and earn a higher interest rate on it. If I blow through my first six months' worth of expenses, by the time I need my remaining money, my CD will have come due, so I won't be looking at a penalty.

Of course, I hope things don't come to that. But either way, I feel that keeping some of my emergency savings in a CD is a financially sound move.

Be careful with your emergency fund

The idea of earning a higher return on your emergency fund may be tempting. But unless you have a larger emergency fund, you probably want to keep all, or at least most, of that money in a regular savings account. What you lose in the form of a lower interest rate than a CD, you gain in the form of peace of mind -- which is the whole point of having an emergency fund to begin with.