Stated vs. APY CD Rates

Investing in CDs may seem like a very straight forward process, but to be a well informed CD investor involves understanding the most important component of a CD, its rates. When you are ready to invest into a CD, you will often notice that there is both a stated and APY CD Rates. Yet, many investors are not aware of the difference in rates of how they affect them. While both are important, it is important to be able to distinguish the actual CD rate being purchased, as this will affect the return of the entire portfolio.

Understanding Stated CD Rates

The stated interest rate refers to the interest rate of the CD expressed as a per year percentage. Why is this important when it applies to CD rates? This rate expresses the total interest rate for the CD, not taking into consideration the effects of compounding. The stated CD rates are often greater for those with longer maturity dates.

For example, the 1 year CD rates will be lower than the 5 year CD rates. The primary reason for this is to pay the investor for the bank’s opportunity to keep their investment for a longer period of time. If shorter term CD rates are higher than longer term CD rates, this is typically a sign that the economy is worsening and is referred to as an inverted yield curve. Overall, the higher interest rate will be often more attractive to the majority of investors, although the longer maturity date and reduced flexibility should be taken into consideration.

Annual Percentage Yield (APY) Interest

The annual percentage yield (APY) refers to the true annual rate of return for an investment, including CDs for a specific year. An APY takes into account the effects of compounding on the interest rate. Compounding refers to the ability to make earnings on your earnings on an annual basis. The APY is generally higher for investments which have interest payments on a more frequent basis. Many investors consider the APY to be the ‘real’ or actual interest rate earned on an investment.

For example, if you purchase a $10,000, 5 year CD with a rate of 5%, you will have an interest payment for the first year of $500. However, the effects of compounding apply and the 2nd year, the interest paid will be based upon the $10,500 amount, not the initial $10,000 principal, yielding an amount of $525 to be paid in interest. Therefore, the balance in the investor’s CD account at the end of the 2nd year will be $11,025, continuing to grow until the maturity date of the 5 year CD.

Both APY and stated interest rates are important when considering CD rates to purchase. The most important thing to consider when it comes to the differences between a stated interest rate and an APY is that the investor will come ahead when they purchase CDs that take into consideration the compounding interest. Be sure to compare CD rates and issuers so that you can make the best investment selection for your personal needs as possible.