A certificate of deposit invests (CD) money over a specific period of time. Each CD has a percentage rate and an annual percentage yield. The percentage rate is a flat rate without consideration of compound interest. Some CDs compound interest daily, monthly, quarterly or annually, and only the annual percentage yield (APY) reflects compounding. The more often the interest compounds, the greater the difference is in the flat rate and the APY. Although you probably want to calculate the CD return rate with a calculator, it’s good to understand how to do it manually.
1. Write out the terms of the certificate of deposit. You need the initial deposit, the interest rate and the compounding frequency to calculate the actual rate of return.
2. Multiply the initial deposit by the interest rate to establish an annual interest estimate without compounding. A $1,000 CD for one year at 3 percent interest will earn approximately $30 for the year. This calculation multiplies the $1,000 by the 3 percent times one year. A six-month certificate will earn approximately half of that amount, or $15. This calculation multiplies $1000 by 3 percent by 1/2 year.
3. Determine the terms for compounding. If your certificate of deposit compounds monthly, calculate the interest for the first month. The $1,000 certificate of deposit at 3 percent annual interest compounded monthly would yield $30 divided by 12 months for the first month, or $2.50. The second month’s interest adds the $2.50 to the calculations so you receive interest on $1,002.50 at 3 percent divided by 12 months. You earn approximately $2.51 for the second month with compound interest. The more often your interest compounds, the higher your rate return will be.
4. Using an interest calculator, check your figures and review the APY. Your $1,000 certificate of deposit at 3 percent annual interest compounded monthly would yield a total of $30.42, based on calculations at Bankrate.com. The annual percentage yield or rate return is 3.042 and the ending balance is $1,030.42.
- A certificate of deposit from an established bank is insured by the Federal Deposit Insurance Corporation.
- The FDIC warns consumers about high-yield CDs that may not be federally insured.
- A certificate of deposit restricts the use of your money, as you lose interest if you withdraw money before the term expires.
- Keith Brofsky/Photodisc/Getty Images