A certificate of deposit, commonly referred to as a CD, is a variation on the standard savings account that offers attractive security and yield in exchange for certain restrictions related to early withdrawals. In a similar fashion to a savings bond, investing in a CD is often considered a "sure bet" due to the extremely low risk involved. Given the fact that CDs are issued by banks and insured by the FDIC up to a sum of $250,000, investors are essentially guaranteed a return on their investment if they comply by the rules set forth during the purchase.
In order to calculate the yield on your CD, you will need two important pieces of information, those being the term length and the interest rate attached to it. With this data, you can quickly begin to assess how your CD will perform over time and whether or not this particular investment platform meets your needs.
Understanding Certificate of Deposit Yield
As mentioned previously, a certificate of deposit operates quite similarly to a savings bond. When you agree to purchase a CD, you are essentially purchasing the guarantee of repayment at a higher value than the purchase price at a specific point in the future. The point at which your CD can be redeemed is typically referred to as the term length. Where CDs differ from savings bonds is the wide variety of term lengths available. For example, the term length of a CD can be as short as a matter of days or as long as several years. It is entirely up to the investor how they pick and choose a CD based upon its term length.
Generally speaking, the term length of the CD is directly related to the interest rate attached to it. An increase in the length of the term will often result in a direct increase in the interest rate of the CD. In some scenarios, term lengths have been known to reach a decade. Once you have committed to a term length and purchased the CD, it is in your best interest to honor the term and avoid early withdrawals. There are often heavy penalties associated with removing your CD funds early, which could entirely negate any profit you may have earned from the investment. It is here where CDs tend to differ substantially from an investment platform such as a savings account. In a savings account, individuals can deposit and withdrawal funds freely from an account which earns a modest yield over time. No penalties are attached to early withdrawals.
Comparing Interest Rates and Yields
That being said, with interest rates at times exceeding 3 percent, the yield on a CD far overshadows that of a savings account. Because of this. many investors are willing to park their funds over the long-term in order to take advantage of the guarantee of this yield in a matter of years. Five-year CDs are very popular among investors, particularly in situations where pending signs of prolonged market uncertainty lead individuals to seek a safe haven for their funds without withdrawing from the market entirely.
It is important to note that the yield percentages on CDs change on a regular basis. With that in mind, some investors choose to speculate on the rise and fall of CD interest rates in order to capture the prime APY for their personal investment. Given the fact that the changes in APY are likely to be quite small, however, casual investors will likely not notice any substantial changes in their return when these rates fluctuate. That being said, it may be worth consulting an investment manager in order to determine when the prime time for these investments may be. Remember, however, that once your interest rate has been established on a normal CD, you will be able to take advantage of this APY regardless of how the market fluctuates throughout the term length.
Creating a Certificate of Deposit Calculator
Once you have decided on the specific length of your CD and identified the corresponding interest rate, you can begin to calculate your yield over the length of the investment. This process involves very little math.
You can take the initial value of your CD and multiply it by the corresponding interest rate – converted to decimal format – to calculate the yield from your first year of ownership. Say, for example, that you have a five-year CD value at $10,000 with a 3 percent annual percentage yield. You can multiply 10,000 by .03 (the decimal-formatted percentage value) to derive a first-year return of $300. At this point, the interest you have earned compounds back into the principal, which means you will be calculating a 3 percent yield on $10,300 for the second year of CD ownership. As you can see, the amount of money earned off of CDs can be quite significant depending upon the size of your initial purchase and the length of time the CD is held.
If you doubt your own abilities to calculate your CD yield, you can use one of several online certificate of deposit calculators available. These tools will allow you to quickly insert vital data points, such as your initial investment, term length and APY, and then derive the total profit form the CD over the length of the investment. When purchasing a CD, you can also speak directly with a representative from your bank, who should be able to offer the same information to you regarding your potential profit from the investment.
Exploring the Benefits of Certificate of Deposit Yield
As you have seen from the certificate of deposit interest formula, the earnings from these tools can be quite impressive. With that in mind, perhaps the most enticing benefit of the CD is both its stability and the noticeably higher yield compared to savings accounts. Additionally, it is important to note that a variety of specialized CDs are also available to investors that allow for specifically tailored investment strategies. Step-up CDs, for example, feature regularly increasing APY rates. With a bump-up CD, individuals have the option to request an increase in their APY if APY rates offered by their bank for similar term lengths increase following their purchase. In fact, certain CDs, such as liquid CDs, even allow individuals to withdraw their funds early for a reduced penalty. With that in mind, there is likely a CD available for the majority of individuals that can match their own strategies and needs.
If you are interested in purchasing a CD, you can speak directly with a representative from your bank to learn more about these tools. As always, you should engage in extensive research and ask any pertinent questions before investing in a CD. Thanks to an abundance of available information, however, you should be able to make your investment decisions with confidence.
Ryan Cockerham is a nationally recognized author specializing in all things innovation, business and creativity. His work has served the business, nonprofit and political community. Ryan's work has been featured at Zacks Investment Research, SFGate Home Guides, Bloomberg, HuffPost and more.