ej105 asked:
I am planning to open up a CD and I need to know the difference between the AnnualPercentage Yield and the Interest rate. Thank you.
Gregory
I have a question about CD’s. What’s the difference between the APY and Interest rate?
Posted in Personal Finance.
4 Responses
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It is the difference between how often an investment is compounded. Go with the highest APY.
The effective annual rate of return taking into account the effect of compounding interest. APY is calculated by ([1+periodic rate]^periods – 1). The resultant percentage number assumes that funds will remain in the investment vehicle for a full 365 days. The APY is similar in nature to the annual percentage rate. Its usefulness lies in its ability to standardize varying interest-rate agreements into an annualized percentage number. For example, suppose you are considering whether to invest in a one-year zero-coupon bond that pays 6% upon maturity or a high-yield money market account that pays 0.5% per month with monthly compounding. At first glance, the yields appear equal because 12 months multiplied by 0.5% equals 6%. However, when the effects of compounding are included by calculating the APY, we find that the second investment actually yields 6.17%, as 1.005^12-1 = 0.0617. Interest rate alone does not rate take into account the compounding of interest within that year
I think the simplest way to explain the difference is that if you multiply the interest rate by the balance you will have in there, it would be the amount of interest you earned in a year if you took the interest out every month. If you multiply the APY by the balance, it would be the amount of interest you earned in a year if you left the interest in the account every month. If you are planning to leave the interest in the account (so the interest can earn interest), look for the highest APY. That will indicate that your interest is compounding at the best possible interval.
I have a question about CD’s too. Why bother? CD’s don’t pay anything because of their safety and some CD’s are just bank paper that isn’t insured by the FDIC. So that with CD’s that are not really CD’s, after the money comes out of your checking or savings account it isn’t insured either.
Go to the Motley Fool website and just start reading.
I don’t know what your bank is telling you about APY but the term isn’t in Barron’s Dictionary of Finance and Investment Terms: ISBN 0-8120-9035-7, about $11 at any bookstore. That should tell you something about your bank.
Interest Rate is the rate of interest charged for the use of money. In a CD you are lending the Bank your money and you are charging them.