The Certificate of Deposit (CD) Calculator can help determine accumulated interest earnings on CDs over time. Included are considerations for tax and inflation for more accurate results.
Certificates of Deposit
CDs are fixed income investments that are offered by many financial institutions (including the largest banks). The process of buying CDs is straightforward; different banks offer different interest rates on CDs. It is important to first shop around and compare maturity periods of CDs, especially their annual percentage yields (APY); this ultimately determines how much compound interest is received on any CD. After comparing rates from different institutions and settling on the best one available, work with bankers to make the transaction. An initial deposit will be required, along with the desired term. Common term lengths range from three months to five years, but the lengthier the term, the higher the exposure to interest rate risk. Generally, the larger the initial deposit, or the longer the investment period, the higher the return. Today, it is rare to receive actual certificates for making deposits, as transactions are usually done electronically.
CDs have relatively low risk and return rates. In 2017, the average one-year CD yield in U.S. is around 0.4%. Historically however, interest rates of CDs tend to be higher than rates of savings accounts and money markets, but lower than the historical average return rate of equities. There are also many kinds of CDs with varying rates of interest, or rates linked to indexes of various kinds. However, the calculator can only do calculations for fixed rate CDs. Funds in CDs may subject to a penalty if withdrawn before maturity (except liquid CDs).
CDs are often used to supplement diverse, intricate portfolios where they can reduce risk. Also, they can act as a short term (5 years or less) place to put extra money that isn't needed or isn't required until a set future date. Because most CDs have fixed rates, estimating future returns accurately is possible for people who require predictability.
In U.S., rates of CD yields have drastically declined since 1984, a time when they once exceeded 10% APY. In late 2007, just before the economy spiraled downward, they were at 4%. In comparison, the average one-year CD yield is just around 0.4% in 2017. Many factors have led to the sharp drops; due to world events and financial cycles, loan demand is no longer high while bank funds have grown. The Federal Reserve, which controls federal funds rate, calibrates them accordingly with concurring economic climates.
In U.S., one of the defining characteristics of CDs is that they are protected by the Federal Deposit Insurance Corporation (FDIC). CDs that originate from FDIC-insured banks, which are most in the U.S., are insured for up to $250,000. These deposits are guaranteed by the FDIC should banks fail. Anyone who wishes to deposit more than the $250,000 limit but have all of it FDIC-insured can simply buy CDs from other FDIC-insured banks. Due to this insurance, there are few safer places to store money.
A CD ladder is a common strategy employed by investors that uses multiple CDs. In this method, CDs are set up so that they mature at staggered intervals. Instead of renewing just one CD with a specific amount, the CD is split up evenly into multiple amounts for multiple CDs. In this scenario, the funds invested are more liquid because as one CD matures, its principal and earnings become available. CD laddering can be beneficial when more flexibility is required, such as allowing access of readily-available invested cash at more frequent intervals, or the ability to purchase new CDs at higher rates if interest rates go up.
APY vs APR
Regarding CD rates, it is important to make the distinction between annual percentage yield (APY) and annual percentage rate (APR). Banks tend to use APR for debt-related accounts such as mortgages, credit cards, and car loans, whereas APY is often related to interest-accruing accounts such as CDs and money market investments. APY denotes the amount of interest earned in an entire year, with compound interest accounted for, while APR generally does not. Due to this, APY is typically the more accurate representation of effective net gains or losses, and it helps that CDs are more often advertised in APY rates. To learn more or do calculations involving APR, please visit our APR Calculator.
The calculator contains options for different frequencies in which interest compounds. As a rule of thumb, the more frequently compounding occurs, the greater the return. To understand the differences between compounding frequencies or to do calculations involving them, please use our Compound Interest Calculator.
Types of CDs
Traditional CD – Investors receive fixed interest rates over a specified period of time. Money can only be withdrawn without penalty after maturity, and there are also options to roll earnings over for more terms. Traditional CDs that require initial deposits of $100,000 are often referred to as "jumbo" CDs.
Bump-Up CD – Investors are allowed to "bump up" preexisting interest rates on CDs to match higher current market rates. Bump-up CDs offer the best returns for investors who hold them while interest rates increase. Compared to traditional CDs, these generally receive lower rates.
Liquid CD – Investors can withdraw from liquid CDs without penalties, but they require maintaining a minimum balance. Interest rates are relatively lower than other types of CDs, but for the most part, still higher than savings accounts or money market investments.
Zero-Coupon CD – Similar to zero-coupon bonds, these CDs contain no interest payments. Rather, they are reinvested in order to earn more interest. Zero-coupon CDs are bought at fractions of their par values (face value, or amount received at maturity), and generally have longer terms compared to traditional CDs, which can expose investors to considerable risk. If interest rates rise during their terms, the opportunity cost of other investments are more financially feasible in hindsight.
Callable CD – Issuers that sell callable CDs can possibly recall them from their investors after call-protection periods expire and before they mature, resulting in the return of the initial deposit and any subsequent interest earnings.