How to Calculate Compound Interest on a CD
Investing in a CD (certificate of deposit) is a safe, low-risk method of investment for first time investors. Not only is your investment guaranteed to increase in value, it also is insured by the FDIC. The bank you get a CD with will let you know how much you will gain from investing; however, you may want to do the calculations yourself before going to your bank to invest.
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Instructions
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Determine the interest rate. You can find this by going to a website such as bankrate.com and it will tell you the current interest rate for CDs (see Resources). For the purpose of the calculation, we will be using a 5-year CD with an interest rate of 3 percent.
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Write out the equation for compound interest: M = P (1 + i)^n [In this guide, the symbol '^' means "to the power of."] M is the final amount you will receive once the investment has matured. P is the principle amount you invested. For this example, the principal amount will be $2,000. i is the interest rate. For this example, the interest rate is 3 percent, to use this in the calculation we need to change it to 3/100 which equals 0.03. n is the number of years you are investing in the CD. For this example the number of years is 5.
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Write out the equation using the information. For our example our equation is now M = 2,000 (1 + 0.03)^5
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Add together the values inside of the parentheses first. You now have M = 2,000(1.03)^5
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5
Calculate the exponential portion of the equation (1.03^5). You now have M = 2,000 (1.28).
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Multiply the remaining values (2000 x 1.28), so M = 2,560.
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Rearrange the equation if you want to find another value. For example, if you want to know how much you need to invest if you want to make a million dollars in 5 years, you can use the following equation:
P = M / (1+i)^n
To determine how much you need to invest to make a million in our example we solve the equation as such:
P = 1,000,000 / (1.03)^5
P = 1,000,000 / 1.28
P = $781,250
This means, to make a million dollars in 5 years you would have to invest $781,250 initially.
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Tips & Warnings
There are many different kinds of CDs with varying years and rates. Do some research into CDs before investing.
