A CD (certificate of deposit) is a convenient tool for a hardcore saver or someone who's simply not interested in a risky investment. It commonly comes with a higher interest rate compared to a standard savings account. In some cases, the interest rate quoted by your CD provider is not the true APY (annual percentage yield interest rate) associated with the account. CD accounts commonly earn interest through compounding—you can figure the true interest rate you're receiving due to compounding by plugging a few key figures into a simple formula.
Gather basic details about the CD account, including the quoted interest rate and how often the interest is calculated—it's commonly once per day, month, quarter or year. Assume for this example that the quoted rate is three percent, and the account compounds monthly.
Plug your figures into the following formula: (r/t+1)^t-1 = true APY where r is the quoted interest rate in decimal form (.03), and t represents the frequency of compounding. The frequency of compounding is 365 if daily, 12 if monthly, four if quarterly and one if yearly. Keep in mind that when the account is compounded yearly, the interest rate quoted is equal to the true APY, so no additional calculation is required.
Figure your true CD interest rate on the account using an exponent calculator (see Resources). In this example, the resulting formula is [.03/12+1]^12 – 1 = true APY. The result is 0.030416, which is equivalent to 3.042 percent.
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- How to Calculate APR Earned on an Investment
- How do I Calculate a Certificate of Deposit?
- How Do Simple & Compound Interest Affect Investment?