An add-on certificate of deposit, or “add-on CD,” is a specialized type of certificate of deposit. It has the same term and withdrawal limits as a standard CD. It differs in that you can add to this account over time, while with a normal CD you can only make an initial, lump-sum investment. It can be difficult to choose the right investments or accounts to save your money, but a financial advisor can help create the right asset allocation if you’re struggling to make the right decision.
What Is a Certificate of Deposit?
A certificate of deposit, or CD, is an investment product offered by banks that puts your money on deposit with the bank making the offer. The bank holds it in an account in the same way that they do with a checking or saving account. However, you cannot withdraw this money for a specific period of time.
For example, say you buy a 60-month certificate of deposit for $1,000. This means that you put $1,000 in a specialized account and cannot withdraw it for five years, or 60 months. If you withdraw the money early you typically pay a penalty fee.
A certificate of deposit account generates interest just like any other bank account. This is the return that the bank pays in exchange for using your money. However, a CD pays extra interest because you’ve agreed to leave the money on the deposit for a specific amount of time.
For example, many checking accounts offer interest rates between 0.01% and 0.1%. Occasionally you will find high-interest checking accounts that can go as high as 0.5%, but these are uncommon and typically reserved for large deposits. By contrast, you can find CDs that pay as much as 3% interest on your deposit. At the end of the deposit period, your CD matures. You receive back all of the money you invested plus interest in one lump sum.
A certificate of deposit is generally seen as a high-security, low-return product. You can’t take your money out at will, so this isn’t good for spending or other uses that require a liquid asset. As a long-term investment product, though, this is about as secure as it gets. You have the backing of your bank and the FDIC to make sure that you get this money back.
But this can be a very low return product. While some CDs can, indeed, offer rates around 3% or higher, banks typically reserve those returns for long-term deposits (10 years or more) in very high amounts ($100,000 or more). Standard CD rates are generally low, to the point where the difference between a CD and a savings account can be negligible. For example, at the time of writing Bank of America offered a 0.01% interest rate on savings accounts and a five-year, $10,000 certificate of deposit for 0.03%.
The difference of 0.02 percentage points is an extremely low rate of return in exchange for locking your money away for five years.
What Is an Add-On Certificate of Deposit?
An add-on CD works in most respects just like an ordinary certificate of deposit. You open an account with the bank. The bank holds your money for a minimum amount of time and, in exchange, pays you a higher rate of interest than normal. The difference is that you can add funds to this account as time goes on.
An ordinary CD is structured as a certificate, as the name suggests because it’s a single asset. Although the money is held in an account, you make one lump-sum investment. The bank holds it and pays you a guaranteed return based on your initial investment.
An add-on CD works more like a bank account. You can make additional deposits to this account over the lifetime of the asset. When the certificate matures, you receive back all of the money that you invested over the lifetime of the asset along with your interest payments.
Example of an Add-On CD
Let’s say you buy a 60-month certificate of deposit for $1,000. Over the five years that the bank holds this money, you put in an additional $4,000 a little bit at a time. When the CD matures you will receive back the $5,000 that you put in (your principal) as well as the interest that accrued over time. Like with all CDs, the interest rate is set when you open the account. The bank can’t change it based on how much or how little you deposit. However, the interest will only build up on money that you currently have in the account. As you deposit more money, the CD will accrue more interest.
An add-on CD can be a valuable asset for investors that don’t have a lot of up-front capital. Many banks require a minimum deposit of between $1,000 and $10,000 to open a traditional certificate of deposit. Investors who don’t have that much on hand may still be able to get a CD by opening an add-on. That flexibility cuts both ways though. An add-on CD will likely pay you an interest rate based on your initial, or minimum, investment. If you are planning on holding this product for a period of years, it might be worth saving up and opening an account with better rates later on.
Finally, add-on CDs are relatively uncommon products. They do exist and are a legitimate product offered by mainstream institutions, but you might have to shop around a little bit to find one.
The Bottom Line
Add-on CDs are certificates of deposit that allow you to invest additional funds during the lifetime of the asset. When your CD matures, you receive back all of the funds you put in plus interest. This can be the right investment if your personal financial situation and goals align with the potential outcome. Working with a financial advisor can help you determine if it’s a good fit, in case you’re not sure.
Tips for Investing
-
If you’re thinking about making a long-term financial plan then you should consider working with a financial advisor. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
-
Certificates of deposit are considered one of the safest investments available today. Now take a look at nine other assets for investors looking to protect their money.
©iStock.com/Moyo Studio, ©iStock.com/Mongkol Onnuan, ©iStock.com/tommaso79
The post What Is an Add-On CD? appeared first on SmartAsset Blog.
Source: finance.yahoo.com