Most investors consider a CD to be a safe, conservative place to hold assets. The assets don't just sit there, though. They earn interest in return. Traditional CDs typically yield returns greater than the rates offered by other insured investments, such as checking and savings accounts. Rates vary from CD to CD, but they are near the current rate of inflation, in general.
When comparing the interest rates of various CDs, it is important to understand the difference between annual percentage yield (APY) and annual percentage rate (APR). APY is the total amount of interest the CD will earn in one year, taking compound interest into account. APR is the stated interest earned in one year, without taking compounding into account. (To learn more, read APR Vs. APY: How The Distinction Affects You.)
Compounding involves the timing of interest calculation (or payment). A CD that pays interest only once a year will yield (in a year) only the exact amount of interest paid. When interest is paid several times a year, the yield total is the sum of the interest from each payment. Because the interest paid during the year earns interest in the account just as the original deposit does, compounded yield is greater than the yield for a once-a-year calculation.
For example, if Yuko purchases a one-year, $1,000 CD that pays 5% semiannually, she will receive an interest payment of $25 after the first six months ($1,000 x 5% x .5 year). The $25 payment begins earning interest of its own, which over the next six months amounts to $0.625 ($25 x 5% x .5 year). As a result, the yield is actually 5.06%, instead of 5% ,for a CD that pays 5% only once a year. The .06 may not seem like much at first, but compounding adds up as both the principal and interest continue to earn interest over time.
While traditional CDs are popular with investors, CDs are also available in a variety of configurations, offering a range of features and investment strategies. Read on to learn about the various models of this conservative place to stash your cash.Certificates Of Deposit: The Basic Model
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