How To Calculate Your CD Account’s Value
Whether it is for retirement or a rainy day, saving money can benefit you in many ways. If you want an option that yields more than mattress storage or your standard savings account but have cash you don’t want to risk investing, you should consider a deposit account such as a certificate of deposit, or CD.
How Do You Calculate Interest on a CD?
CDs earn compound interest, at different compound frequencies, which makes them attractive to investors who are risk-averse. This means that CDs earn interest periodically, which will depend on the CD terms and term length.
Compared with simple interest, compound interest grows your money faster, but it also makes being your own CD calculator a little more challenging. How is CD interest calculated manually? Here’s the formula to calculate the value of an investment that pays compound interest, like a CD.
Formula for Calculating CD Interest
A = P(1+r/n)(nt)
- A is the total that your CD will be worth at the end of the term, including the amount you put in.
- P is the principal, or the amount you deposited when you bought the CD.
- R is the rate, or annual interest rate, expressed as a decimal. If the interest rate is 1.25% APY, r is 0.0125.
- n is the number of times that interest in compounded every year. Most CDs pay interest that is compounded daily, so n = 365. Check with your bank to verify the interest is compounded daily.
- t is time, or the number of years until the maturity date.
For example, take a look at a deposit of $10,000 in a five-year CD at 2.50% APR, compounded daily.
Here’s the calculation:
- A = 10,000 (1+0.025 / 365) ^ (365*5)
Using the correct order of operations, here’s the process:
- A = 10,000 (1+0.000068493150685)^(365*5)
- A = 10,000 (1.000068493150685)^(365*5)
- A = 10,000 (1.000068493150685)^1825
- A = 10,000 (1.133143602492102334771122378642)
- A = 11,331.44 (rounded)
The total at the end of five years would be about $11,331.44. Because you deposited $10,000, you earned $1,331.44 in interest.
How much does a $10,000 CD make in a year? If your APR is 2.50% and your term length is one year, you would earn around $266.29 in interest. Of course, your earnings would depend on the APR, term length and other term conditions of the CD.
APR vs APY
When you compare CD interest rates, make sure you’re comparing apples to apples. The calculation above is based on the annual percentage rate, or APR, of 2.50%. The annual percentage yield, or APY, is 2.531%. The APY will always be higher than the APR because of the compound interest.
What Is a CD?
CDs are financial products that pay a guaranteed rate of interest. CDs are issued by banks, so they’re covered by FDIC insurance, just like your checking account, money market account or savings account.
A traditional CD is considered a time deposit, because you purchase it for a specified period of time — such as one, five or 10 years. If you redeem a CD before the maturity date, you’ll typically pay an early withdrawal penalty based on the terms of the agreement.
What to Do When CD Rates Change
Investing in a CD in your local or online bank or credit union means you’ll have your money tied up for a specified length of time at a fixed interest rate. Interest rates rise and fall, so you might find yourself a year or two into a CD that’s paying a much lower rate than you could get elsewhere.
Other factors to consider include no-penalty CDs, brokered CDs, automatic renewal and minimum balances.
Rising Interest Rates
A bump-rate CD will let you increase your rate, usually one time during the term of your CD, to the current rate. Another option is to strategically ladder your CDs. With CD ladders, your money is invested in CDs with differing terms. For example, rather than buying a three-year CD for $15,000, you could buy three $5,000 CDs with different maturity dates ranging from monthly to yearly.
When Inflation or Taxes Increase
CD interest is taxable in the year you earn it, even if you don’t take the money out — unless it’s in a qualified account like an IRA. It might make sense to use CDs for your tax-qualified investments, like IRAs, and take more risk to get a better return in your non-tax-qualified accounts.
Now that you understand how to calculate the interest earned on a CD, you can compare the rates offered by different banks and choose the one that best fits your needs.
CD interest rates vary by the length of time; generally, the longer the term, the higher the rate. Rates are typically higher for larger deposits, with jumbo CDs typically offering the highest rates. To make an informed decision about which type of CD is best for you, you have to consider its value and what financial institution offers the best one for you.
Karen Doyle contributed to the reporting for this article.