You have likely heard of Certificates of Deposit, or “CDs”, but how much do you actually know about this low-risk investment option? Did you also know that there are different types of CDs to consider, including “add-on” versions?
Below, we dive into exactly what a certificate of deposit is, and explore some of the CD variations that might work best for you.
What is a Certificate of Deposit?
A certificate of deposit allows you to earn interest on a lump-sum of money that you deposit at a bank or credit union, and agree not to withdraw for a specified amount of time. The interest rate earned with a CD is typically higher than that of a traditional savings account. Basically, the financial institution pays out a higher interest rate to you in exchange for the promise of you keeping your deposit there until the CD term length ends. This is typically referred to as the CD’s “maturity date”. Banks and credit unions typically offer a variety of CD term lengths, and most will require a minimum deposit in order for you to open the CD. In most cases, the longer the CD term you agree to, the higher your rate of return.
Certificates of deposit are commonly referred to as “safe” investments, due to the fact that they are insured, like other traditional bank accounts. As long as the financial institution offering the CD is FDIC or NCUA insured, any deposits you have there that don’t exceed $250,000 will be covered. Some financial institutions even offer additional coverage for deposits that exceed FDIC or NCUA limits. BankFive, for example, is part of the Depositors Insurance Fund, which insures all deposits in excess of the FDIC’s $250,000 coverage limit.
Another difference between a CD and a savings account is that with a CD, you typically “lock in” your rate for the entire term. So, if you open a 12-month CD with an annual percentage yield of 0.35%, but then two months later the bank changes the rate of that CD to 0.25%, you’ll still be locked into your 0.35% rate. With a savings account on the other hand, your rate of return will typically change every time the bank changes that product’s interest rate.
CDs also differ from savings accounts in that they don’t usually allow you to add additional funds after the term length begins. With a savings account you can deposit funds on a daily, weekly, or monthly basis, helping to grow your nest egg. With a CD on the other hand, you generally make your entire deposit when opening the account, and let the interest rate grow your funds over time.
In some cases, it’s possible to withdraw funds from a CD before the maturity date, but doing so will typically result in an early withdrawal penalty fee. For this reason, you should only place money in a CD if you’re confident you won’t need it before the term length is up.
The most common CD term lengths range from six months to five years, with various terms in between that time-frame. When a certificate of deposit matures, you generally have the option to either withdraw your deposit and the interest earned, or roll the funds over to new term.
Add-On CDs
While a traditional CD will typically not permit you to add funds after account opening, an add-on CD allows you to do just that. With an add-on CD, you can usually add money to the account at any time during the term length, like you can with a savings account. This allows you to grow your investment at a faster rate since you can earn interest on both your initial deposit and the funds you add over time. You can also still benefit from locking in an interest rate that is typically higher than a traditional savings account. Be aware though, that the terms and conditions for add-on CDs will differ depending on the financial institution offering them. Some may have restrictions on how much, or how often, you can deposit money into the CD. Because of this, it’s a good idea to read all of the fine print associated with the CD before opening your account.
Like a traditional CD, your money is “locked” for the duration of the CD term when you open an add-on CD. This includes any funds that you add to your initial deposit over time. Because of this, it is important to be sure you will not need those funds before the CD matures, as you will likely face a penalty for withdrawing money from the CD early.
Find the CD that’s right for you.
No matter which CD option you are considering, the most important thing is to understand exactly what you are agreeing to. If you have funds that you won’t immediately need, a certificate of deposit can be a safe way to grow your investment over time, and an add-on CD could provide you with additional flexibility if needed.
BankFive offers a variety of CD options for you to consider, including a 2 Year Add-On CD. If you have any questions about investing with certificates of deposit, don’t hesitate to contact us today.