Today, I tackle related questions from two readers -- one about CD rates and another about money market account rates.
Dear Dr. Don,
Please explain how the interest on a six-month CD at 2.26 percent is determined. Do you make 2.26 percent in six months? I doubt it, so how does the six months figure in?
-- Nancy Numbers
Banks quote yields on an annualized basis so you can compare yields across accounts. When a bank quotes the yield on a six-month CD as 2.26 percent, it's quoting an annualized yield. You'll earn roughly half that yield on a six-month CD. That makes much more sense than the assumption you'll earn 4.5 percent annualized in today's interest rate environment.
There's a difference between the nominal yield paid on the account and the effective yield based on how frequently interest is credited (paid) to the account. The more frequent the compounding, the higher the effective yield. Banks are required to provide the annual percentage yield on the account when advertising yields.
Bankrate's CD calculator lets you input the variables to arrive at the value of your savings when the CD matures.
I played around with the calculator inputs and assumed that a $10,000 CD paid a nominal rate of 2.26 percent, compounded monthly over six months, for an APY of 2.28 percent and total interest paid of $113.53. You can use the actual terms of the CD to arrive at a more precise number for your savings.
Take a look at an earlier column, "How interest compounding affects yield," for more on the topic.
Dear Dr. Don,
If I were to put $20,000 in a money market account for 15 months with an annual percentage rate of 2.55 percent, what would my gain be at the end of the 15 months?
-- Cheryl Compound
Under the Truth in Savings Act, banks advertising an account's yield are required to post the annual percentage yield on the investment. This allows consumers to compare accounts on an apples-to-apples basis.
The APY considers the nominal, or stated, yield earned on the deposit and how frequently interest is credited (paid) to the account. Bankrate's CD calculator lets you input the variables to arrive at the value of your savings in 15 months.
I played around with the calculator inputs and assumed that your CD paid a nominal rate of 2.52 percent, compounded monthly over 15 months, for an APY of 2.549 percent and total interest paid of $639.35. You can use the actual terms of your money market account to arrive at the number.
One caveat: A money market account isn't a certificate of deposit. The bank can change the yield paid on its money market accounts. You're not guaranteed to earn the 2.55 APY over the next 15 months. Your interest earnings will change with the changing yield paid on the account.
To ask a question of Dr. Don, go to the "Ask the Experts" page, and select one of these topics: "Financing a home," "Saving & Investing" or "Money." Read more Dr. Don columns for additional personal finance advice.
Create a news alert for "CDs"