Why a CD Is Not a Good Place for Your Emergency Fund

You may be better off keeping that money in a regular savings account.

At the start of the COVID-19 pandemic, a lot of people learned the hard way that not having an emergency fund is bad news. In 2020, millions of Americans lost their jobs, and in the absence of having savings to fall back on, many struggled immensely.

As a general rule, it's a good idea to have an emergency fund with enough money to cover at least three full months of essential living costs. And if you're able to aim higher, that's even better.

The purpose of your emergency fund is to get you through a period of unemployment and/or cover large unplanned bills that pop up, like home and car repairs. And if you're wondering about that three-month rule of thumb, it's because it might easily take that long to find a new job after becoming unemployed.

But while it's crucially important to have an emergency fund to begin with, it's just as important to find the right home for that cash. And in that regard, your best bet really is a savings account, not a CD. Here's why.

You need easy, penalty-free access to your money

The upside of putting money into a CD (certificate of deposit) account is getting to snag a higher interest rate on it. The downside, however, is that you must commit to locking your money away for the entire term of your CD. And if you cash out your CD early, you'll be penalized financially.

Now, each bank can set its own penalty for an early CD withdrawal. But to give you a sense of what penalty you might be looking at, Wells Fargo charges a penalty of three months of interest for cashing out a 12-month CD before it comes due. And the penalty for cashing out a 24-month CD early is six months of interest.

Because early cash-out penalties can negate all of your interest earnings, a CD is simply the wrong place for your emergency fund, because the whole purpose of having one is to be able to tap it as needed. Also, with a savings account, you can withdraw a small portion of your balance if that's all the money you need to cover an unplanned bill. CDs generally don't allow for partial withdrawals -- if you have a $10,000 CD and only need $1,000 to pay a surprise bill, you have to cash out your entire balance.

A good place for your extra money only

You may be tempted to put your emergency fund into a CD to earn more interest on your cash. But a better bet is to stick to a regular savings account.

Now that said, if you have money outside of your emergency fund that you're not ready to invest, then by all means, open a CD. You might, for example, want $15,000 in your emergency fund. If you have $18,000 in cash, there's no reason not to open a $3,000 CD and enjoy extra interest on that money. But otherwise, stick to a traditional savings account, even if it means earning a little less interest along the way.