Emergency Fund: CD Ladder or I Bonds?

Question

I've been living below my income for a while now, and built up an emergency fund of 12 months comfortable expenses/18 months bare-bones expenses. Currently it's sitting in a savings account earning a fraction of a percent interest, but I'd like to get it doing a little more work for me without exposing it to more risk. (This is separate from my retirement account, I have that in a mix of index funds, but I don't want to put my emergency fund in stocks for the obvious reasons.)

I'm looking at doing either a CD ladder (about 3.2% interest on 5-year CDs, but I'd start with a lower rate on the shorter CDs) or a ladder-type thing with I Bonds (apparently over 9% interest right now but who knows how they'll change). Downside of a CD ladder seems to be the lower interest rate and it would take a lot more work to set up, downside of an I Bond ladder seems to be that you literally can't get the money for 12 months, so I'd have to keep 6 months of expenses outside it until the first bonds were a year old.

Am I missing a catch somewhere? How long does it actually take to get your money back out of I Bonds if you need it (after the 1 year deadline)? Is a bond ladder actually a better idea?

Answer 1

The point of an emergency fund is that you can access it in an emergency - imagine if your car is wrecked and not covered by insurance, or your house is damaged.

Whatever you put it in, it cannot be something that has a significant difficulty in removing it at a moment's notice. That means I-Bonds are a no-go for the truly emergency portion of the funds. CDs are an option, but only CDs that have a reasonable penalty for early withdrawal - some have a penalty that's very long.

All that said, you have 12-18 months of income - that's far more than the truly emergency portion you need (say, 6 months). Keeping 6 months in something relatively safe and accessible while putting the rest in whatever you feel most comfortable with seems perfectly fine.

Do take into account, however, how much work some of these strategies are - CD ladders for example can be very time consuming and require you to be on top of them.

Also, don't expect I-Bonds to pay 9% for very long - this is likely a one-time-only opportunity with I-Bonds, in a year or two inflation may well be 3%, 1%, or even negative. (It could be this high, but I wouldn't peg that as very likely.) CD rates on the other hand probably won't move down much in the medium term - more likely interest rates are going up still, so that 3% will look a lot better in a year or two when it's 4% and the I-Bond is 2%.