APY on CDs

December 19, 2006 6:29 AM

Please help me understand APY vs. interest rate on 6 month CDs so that I can stop being paranoid about getting ripped off.

Let's say exactly one year ago I opened a 6 month CD with 20,000 dollars at an interest rate of 5.4 with an APY of 5.6. After one year, shouldn't my balance be greater than 21,000 given that 5.6% of 20K is like 1200 or so and should be compounded with the interest from the first 6 months? I don't understand why my balance us UNDER 21000 after a year with a 5.6% APY. How is this supposed to work?

posted by spicynuts to Work & Money (18 answers total)

Best answer: Your interest is calculated daily. 5.4%/365.

You don't earn 5.6% on the entire original principal, you earn COMPOUNDED interest on the accumulating balance, based on 5.4% annual rate. Compounding raises the effective rate of interest on the principal amount and is related to the interval they use to calculate the interest. (It is most effective with shorter compounding intervals... daily versus quarterly. If done annually, it has no effect.)

You're not being ripped off.
posted by FauxScot at 6:35 AM on December 19, 2006

Yes, you should have $21,120. Perhaps they didn't realize you wanted to reinvest the $552 in interest from the first six months?
posted by raf at 6:36 AM on December 19, 2006

FV=P(1+(5.4%/365))^365 in 1 year, compounded daily.

APY% = [(FV/P)-1]*100
posted by FauxScot at 6:38 AM on December 19, 2006

Shouldn't something have happened at the 6 month mark? Either rolled over into a new CD at a new rate, or put into a savings account, or something else you haven't specified.
posted by smackfu at 6:39 AM on December 19, 2006

Best answer: You should have $21,109.
posted by FauxScot at 6:40 AM on December 19, 2006

Does the amount you have equal the result of earning the appropriate amount of interest for 6 months? I'm not in the USA so I don't know how this particular investment product usually works, but I would usually assume that if it's got "6-month" at the beginning of the name, then it's done after six months.
posted by winston at 6:50 AM on December 19, 2006

Response by poster: I auto-rolled it over at 6 months. At that time I was confused at my balance but assumed they know what they are doing and I don't. At the one year re-roll over I started to think maybe I should ask some questions. Et voila, here I am.
posted by spicynuts at 6:53 AM on December 19, 2006

Response by poster: I do not have 21,109. I have 20,986. Perhaps I opened this at a lower interest rate and they upped it at the 6 month roll over. I'll have to check my records at home tonight. But thank you FauxScot for doing the calculations. Much appreciated.
posted by spicynuts at 7:04 AM on December 19, 2006

spicynuts, I think you solved the problem with your last comment. The interest rate gets re-determined every time your CD is renewed. With the interest rates on the rise for the past 12 months, you very likely started out with a lower interest rate, and then when the first 6-months was over, the CD was automatically renewed at the then effective interest rate, which would have been higher under normal circumstances (unless the bank had promotional rates the first time around).
posted by tuxster at 7:11 AM on December 19, 2006

$20,986 = an initial balance of 20,421 invested for six months at an APY of 5.6% This suggests the APY for the first six months was in the neighborhood of 4.26%, if you started a year ago with $20k.

Is that in the ballpark?
posted by Opposite George at 7:50 AM on December 19, 2006

I'll just note for the record that you should have $21,109 if in fact the rate is 5.4% (which implies an APR, compounding daily, of 5.548%); you should have $21,120 if in fact the APR is 5.6% (which implies an interest rate, compounding daily, of 5.449%). One of your numbers is rounded, and without knowing which, it's impossible to know which outcome is correct. (I agree, though, that it looks like your first CD wasn't at that rate.)
posted by raf at 9:16 AM on December 19, 2006

Response by poster: Hmmmm...no, the original APY was absolutely over 5, which is why I picked the particular bank.
posted by spicynuts at 9:16 AM on December 19, 2006

Would you let us know when you figure it out? This one has me scratching my head.
posted by ikkyu2 at 10:21 AM on December 19, 2006

Response by poster: Absolutely. It has me scratching my head too.
posted by spicynuts at 10:31 AM on December 19, 2006

Response by poster: By phone the bank confirms that the interest rate when opened last year was 5.1. They could not tell me the APY. I'll have to check that when I get home tonight.
posted by spicynuts at 10:59 AM on December 19, 2006

You are short about $90, based on the calculation as follows:

FV1 =P(1+(5.1%/365))^183 = ~ $20,518

FV2 = FV1(1+(5.4%/365))^182 = $21,076.

Maybe you ARE being ripped off! I shoulda done the calcs before declaring otherwise. My apologies.
posted by FauxScot at 12:37 PM on December 19, 2006

Any chance you paid some sort of transaction fee?
posted by mullacc at 1:53 PM on December 19, 2006

Response by poster: Nope. Looks like the real reason is I'm an idiot. This is why I should not look at anything that requires thinking the day after the office xmas party. Looking at my records, the rate when I opened the CD last year was 4.5/4.55. It went to 5.09/5.15 at the first 6 month interval and then to what it is now. In my hungover state I confused the opening rate I had for my online savings account and that's why I thought I was over 5.0 to begin with. Sorry about that people and thanks for the help anyway. At least now I understand how APY works.
posted by spicynuts at 6:31 PM on December 19, 2006