It can be difficult to save money that is kept in a standard savings account because of the temptation of using the funds for other needs. Savings accounts provide easy access, but certificates of deposit, CDs, accounts make it more difficult to make withdrawals. Learn about CDs and calculate the interest accrued at maturity.
What Is a Certificate of Deposit?
A certificate of deposit is a type of savings account that can help you discipline yourself to save. You must add money to the account initially then allow the funds to generate interest over a specific period of time. You can set a specific end date for the account, usually six months or longer. If you try to withdraw money from the CD earlier than the term set at the beginning of the account, the bank may charge penalties. Putting money into a CD account is a lower risk way to make money on savings compared to investing.
Types of CDs
Some banks offer additional options besides a traditional CD account. With a bump-up CD account the bank raises the interest rate if a higher one becomes available during the term. Liquid CDs allow you to withdraw a certain amount of the deposit and avoid paying a fee. If you sign up for a callable CD account the bank can change its mind and close the account at any time --- usually because the interest rates fall below the initial rate on the CD account.
CD Calculation
Banks calculate the interest earned on CDs using a compounding formula. Compounding means that interest is earned on interest during the term of the account --- this calculation method is beneficial for a saver. The most common compounding frequency is monthly, but some banks also compound interest daily, quarterly or annually. The three main factors that go into calculating a CD account besides the compounding frequency are the rate, term and initial deposit.
Formula and Example
The formula for calculating the value of a CD account at maturity is "(i/c*t+1)^c * p" where "i" is the yearly interest rate, "c" is the compounding frequency, "p" is the principal amount deposited into the CD account and "t" is the term in years. So as an example, a CD account with a 2 percent rate that compounds monthly with an initial deposit of $10,000 and a term of two years will be worth about $10,407, [.02/12*2+1]^12*10000, at maturity.
Tags: account bank, compounding frequency, calculate interest, during term, initial deposit, interest earned
