Ready to begin building up a healthy amount of savings? First,
it’s important to understand the very cool concept of compound
interest, and to do that you’ll need to know the difference between
an interest rate and yield.

**Rate** is the nominal, or stated, interest rate
on the investment. If you have a CD with a stated interest rate of 5%, the
interest is calculated by multiplying the amount invested by 5% and
by the fraction of a year the money is invested.

Let’s say interest is paid annually. A $10,000 investment will
earn $500 in interest per year ($10,000 x 5% x 1 year = $500).

**Yield** represents the interest that will be
earned not only on your investment amount but also on your interest
as it builds. The interest paid on the interest you’ve already
accumulated is called **compound interest**.

When an investment pays interest annually, its rate and its
yield are the same.

But when interest is paid more frequently, the yield rises.
That’s because the interest payment is credited to the CD more
quickly and it starts earning interest along with the invested
principal.

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### Annual vs. compounding interest

###### Annual interest

Let’s say a $10,000 CD investment earns 5% interest, paid
annually: After one year, you would have:

**$10,000 x 5% x one year = $500 interest**

**Total interest: $500**

###### Annual yield

If that same CD pays interest twice a year, after 6 months you
would have:

**$10,000 x 5% x 0.5 years = $250 interest**

During the second half of the year, you also would earn:

**$10,000 x 5% x 0.5 years = $250 interest**

But the $250 in interest earned during the first half would
start earning interest, too:

**$250 x 5% x 0.5 years = $6.25 interest**

**Total interest: $506.25**

The rate and yield on the first CD is 5%. The rate on the second
CD is 5%, but its yield is 5.06%.

To get that yield you must reinvest the interest. That’s what
compound interest is all about.

Bankrate.com has several calculators
that can help you achieve your savings goals.

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