Dawn of the Geeks

A Certificate of Deposit or CD is a product a bank offers that allows you to earn a larger interest rate. A CD uses Simple Interest to calculate how much you will earn over a certain period of time. In exchange for the higher interest rate the bank typically requires that you leave the money in the account for the entire duration that you agreed upon when signing up for the CD. Taking your money out early could result in penalties.

Currently ING is offering a CD with a yield of 4.00% over 12 months. So if you deposit $1000.00 into this CD you will make $40.00 in interest at the end of 12 months.

Since a CD is simple interest, let’s determine what the equivalent compound interest rate would be assuming that the interest is compounded monthly.

PV is the present value which is the amount you start with. In this case we started with $1000.00. FV is the future value or the amount you will have at the end. In this case we will have $1040.00. N is the number of periods that we are compounding the interest. Since we’re compounding monthly for a year N would be 12.

However, “i” is the periodic rate. We multiply by 12 to get the annual rate which is about 3.9%.

So you would need to put your money into a savings account with a 3.9% rate in order to match the return of a 4.00% CD.

Currently ING is offering a savings account with a 2.75% APY. So you can see that in exchange for keeping your money in one place banks are willing to offer a higher interest rate. When deciding whether or not to put your money into a CD you need to consider the return compared to a regular savings account and the potential need to have access to the money.

So with compound interest over 12 months at 2.75% you would end up with $27.85 in interest; $12.15 less than the CD.

So in effect it costs you $1 per month to have unrestricted access to your money.

The potential money you make in a CD over what you would earn in a high yield savings account may not justify locking your money away. If you think you may need the money prior to the end of the period required by the CD then you should not put it into the CD.