All certificates of deposit earn interest. But not all calculate it the same, or pay it out on the same schedule. Before locking into a new CD, it’s worth checking its interest terms.
First look for how frequently the CD will compound. Compounding monthly means one month’s worth of interest will be added to the balance each month. Then the next month, that new higher balance will be used for calculating interest.
Certificates generally compound daily, monthly, quarterly or even annually. The more frequently, the better, as it allows more chances to earn interest on accrued interest.
To see the impact of different compounding periods, take the example of a five-year CD with a 2.50% APR and an investment of $20,000. If compounding annually, the CD would earn $2,628 over the five years, while the same CD with daily compounding would earn $2,663.
Although the difference might seem small, it can sometimes help you choose between two otherwise equal CDs.
The other aspect of CD interest to consider is the ability to tap interest before maturity. Most CD buyers will keep their interest accumulating within the CD, growing the balance and benefiting from compounding.
But some CDs allow you to siphon the interest into a separate account each time the CD earns an interest payment. Here again, the terms of the CD will stipulate how often that happens. Though a CD might compound daily, most banks will apply interest payments monthly or quarterly.
If your goal is to earn the highest possible return over the life of your CD, you’ll want to choose a certificate that allows interest to accumulate and be compounded. But if instead you’d like to preserve your main investment while collecting interest payouts along the way, check the terms to make sure periodic interest withdrawals are allowed.