If you Google the term “emergency fund,” you will find many articles on what an emergency fund is and why you should start one. I started one in the April of 2013; I opened a 2-year raise your rate CD account with Ally Bank. The opening balance was $7,000 and the beginning annual percentage yield was 1.09%. At that time, I really thought I would not need that sum of money in the next two years.
However, in the April of this year, an investment opportunity came up. This opportunity was one that I really could not pass up. I needed cash, so I had to close my account early. I was searching on the Ally Bank website to see if I could do it online and transfer the balance to my regular bank account. It turned out I needed to call customer service to close the account.
On 4/21/2014 I gave them a call. Their phone representative asked me a few security questions to verify my identity. After providing her with that information, she then went on to ask me where I want the money to be deposited. She informed me that my early withdrawal penalty came out to be about $12.57 (60 days of interest) and the money will be in my non ally bank account on Tuesday 4/29 the latest. Much to my surprise, my regular bank account was credited on 4/23 in the amount of $7,066.25. It took only two days, way sooner than I expected. That was it. The entire process was quick and simple.
During the coming tax season, I will have to report the interest that is accrued in 2014 on my 2014 tax return. The good news is, the early withdrawal penalty is tax deductible. It will be an adjustment to income:
Closing out the account got me to wonder if opening a CD account was a mistake in the first place. Stocks had done very well in 2013. The S&P 500 had an annual percentage gain of ~30%. I am not saying that I definitely could have beaten the S&P500. But had I invested the $7,000 in stocks rather than a CD, I think I would have done better than $66.25. Hindsight is always 20/20 though. I was looking for a safe place to put my emergency fund. The stock market may have a higher reward, but it also has a higher risk. It is not the place to put an emergency fund (no matter how tempting it may be).
What if I put the $7,000 in an Ally Savings account instead? How much interest would I have lose out? For simplicity, let’s assume that (1) the CD does reach maturity and (2) the rate remains at 1.09% for the entire 2-years.
2-year raise your rate CD, 1.09% annual percentage yield:
Ally Savings, 0.87% annual percentage yield:
The difference is $31.41. So had I put my money in Ally Savings instead, the most I could lose out is around thirty something dollars.
With the early withdrawal, what actually happened was that the $7,000 was in the CD account for a total of 378 days. If I put the money in an Ally Savings account, I would have gotten approximately $61.62 of interest. This is slightly less than the $66.25 that I actually received, but would have given me better access to my money. (Trust me, there were many days in 2013 where I just want to close out the account and invest in the stock market.) The difference is small enough that I am not sure if putting my money in a CD is a smart move after all.
Maybe my mistake was putting too much money into the CD. Maybe I should have just put $1,000~$2,000 into the CD and the rest into my savings account. I am trying to save up an emergency fund again. This time, when I have accumulated a nice sum of money (say $5,000-$7,000), I won’t put it in a CD. Don’t get me wrong though, I like Ally Bank, I still have a savings account with them. The rates on their CDs are very competitive with similar products out there. It’s just that a CD is not a financial instrument that fits my financial needs given the current interest environment.