CD Compound Interest: How Certificates of Deposit Grow Your Money

How CD Compound Interest Works

When you open a CD, you deposit a fixed amount of money for a fixed term (typically 3 months to 5 years) at a fixed interest rate. The bank pays you interest on your deposit, and that interest compounds — meaning each period, you earn interest on both your original deposit and all previously earned interest.

The CD Compound Interest Formula

For a typical CD that compounds daily:

• A = Maturity value
• P = Deposit amount
• r = Annual interest rate (APR)
• n = 365 (daily compounding)
• t = Term in years

Example Calculation

$10,000 CD at 4.75% APY for 12 months with daily compounding:

Note: When a bank advertises a 4.75% APY, that rate already accounts for daily compounding. The actual APR (nominal rate) would be slightly lower at approximately 4.641%.

How CDs Accrue and Pay Interest: Daily Accrual and Payout Options

Understanding the mechanics of how CDs accrue interest is essential for maximizing your returns. While the compounding frequency determines how quickly your money grows, the payout schedule affects when you actually receive your earnings and how you can use them.

Daily Interest Accrual

Most banks calculate (accrue) interest on your CD balance every single day. This means your balance grows incrementally each day, even though you may not see the credited amount until the end of the month. Daily accrual ensures you earn the maximum possible interest because each day's calculation includes all previously accrued interest from that month.

For example, on a $10,000 CD at 5.00% APY, the daily interest accrual is approximately $1.37 per day ($10,000 x 0.05 / 365). By the end of the first month, you have accrued roughly $41.67 in interest, which then gets credited to your account.

Interest Payout Options

Banks typically offer several options for handling your earned CD interest:

• Compound into CD (reinvest): Interest is added to your CD balance, where it continues to earn interest. This maximizes growth through true compounding and is the default option at most banks.
• Transfer to linked account: Interest is automatically deposited into your checking or savings account each month or quarter. This provides regular income without touching your principal.
• Mail a check: Some banks will mail you a physical check for your interest earnings. This option is less common and may only be available for larger balances.
• Pay at maturity: All interest is paid out in a lump sum when the CD matures. This simplifies accounting but may result in slightly lower effective yields if the bank doesn't compound during the term.

Choosing the Right Payout Option

For maximum growth, always choose to reinvest (compound) your interest back into the CD. However, retirees or those seeking regular income may prefer monthly transfers to a linked account. The difference can be meaningful over time: on a $50,000 five-year CD at 4.75% APY, reinvesting all interest earns approximately $650 more than taking monthly payouts, because those monthly withdrawals miss out on compound growth.

When comparing CD offers, confirm both the compounding frequency and the default payout option. Some promotional CDs with attractive headline rates may compound annually rather than daily, or may default to paying interest to a separate account rather than reinvesting. Use our compound interest calculator to model different scenarios and see how payout choices affect your total returns.

CD Earnings at Different Rates and Terms

Here's how $10,000 grows in CDs at various rates and term lengths (daily compounding):

A 5-year CD at 5.00% APY turns $10,000 into $12,763 — earning $2,763 in compound interest with zero risk to your principal.

CD Rates vs. Savings Account Rates: A Detailed Comparison

One of the most common questions savers face is whether to put their money in a CD or a high-yield savings account. Both products offer FDIC insurance and compound interest, but they differ significantly in flexibility, rates, and optimal use cases.

Current Rate Comparison: CDs vs. High-Yield Savings

Growth Comparison: $25,000 Over 3 Years

The following table shows how $25,000 grows over three years in different scenarios, illustrating the trade-offs between CDs and savings accounts:

When CDs Beat Savings Accounts

• Rates are expected to fall: Locking in today's rate protects you from future rate cuts
• You have a specific time horizon: Saving for a known expense in 1-3 years
• You want guaranteed returns: CDs remove rate uncertainty entirely
• You need spending discipline: The withdrawal penalty discourages impulsive spending

When Savings Accounts Beat CDs

• Rates are expected to rise: Variable rates let you benefit from increases
• You need liquidity: Emergency funds should always be accessible
• Uncertain timeline: If you might need the money unexpectedly
• Small rate difference: If CD rates are only marginally higher, flexibility may be worth more

For most savers, the optimal strategy combines both products: keep 3-6 months of expenses in a high-yield savings account for emergencies, and put longer-term savings into CDs or a CD ladder for higher guaranteed returns. For a comprehensive comparison of all available rates, see our best compound interest rates guide.

CD Earnings at Different Deposit Amounts

How much interest do you earn on various deposit sizes at 4.75% APY (daily compounding)?

Remember that FDIC insurance covers up to $250,000 per depositor, per bank. If you have more than $250,000, spread your CDs across multiple banks to maintain full insurance coverage. For a broader perspective on how rates compare across products, see our best compound interest rates guide.

How CD Compounding Frequency Affects Your Earnings

Not all CDs compound at the same frequency. Here's the difference on a $10,000 deposit at 5.00% APR:

Daily compounding earns $77 more than annual compounding over 5 years on $10,000. While modest, this difference increases with larger deposits. On $100,000, that's $770 more over 5 years.

CD Laddering Strategy: Maximize Returns While Maintaining Flexibility

A CD ladder is a strategy where you split your money across CDs with different maturity dates. This provides regular access to your money while capturing higher long-term rates. CD laddering is one of the most effective ways to balance the trade-off between earning higher rates on longer-term CDs and maintaining liquidity.

How to Build a CD Ladder

With $50,000 to invest, you might build a 5-year ladder:

As each CD matures, you either use the money or reinvest into a new 5-year CD. After the first year, you have a CD maturing every year, giving you annual access to your funds while earning higher long-term rates.

CD Ladder Example: $60,000 with Quarterly Maturities

For more frequent liquidity, consider a shorter ladder with quarterly maturities:

After the first year, you have a 12-month CD maturing every quarter, providing access to $15,000 every three months while earning competitive 12-month CD rates on all your funds.

Benefits of CD Laddering

• Liquidity: A CD matures every year (or more frequently with a shorter ladder), so you always have access to some funds without paying early withdrawal penalties
• Rate hedging: If rates rise, you reinvest maturing CDs at higher rates. If rates fall, your existing long-term CDs lock in the higher rate
• Higher average yield: Long-term CDs typically offer higher rates, and a ladder lets you capture those rates while maintaining flexibility
• Reduced timing risk: You avoid the risk of locking all your money into CDs right before a rate increase

Use our CD calculator to model different ladder configurations and see how they affect your total returns over time.

Early Withdrawal Penalties and Their Impact on Your Returns

If you need your money before the CD matures, you'll face an early withdrawal penalty (EWP). Understanding these penalties is crucial for choosing the right CD term and avoiding costly surprises.

Typical Early Withdrawal Penalties by Term Length

How Early Withdrawal Penalties Are Calculated

Early withdrawal penalties are typically expressed as a certain number of months' worth of interest. The penalty is calculated based on the CD's interest rate, not on the interest you've actually earned. This means:

• If you withdraw very early: The penalty can exceed your earned interest and eat into your principal
• Example: If you withdraw from a 12-month CD after only 2 months and the penalty is 6 months of interest, you'll lose your 2 months of earned interest plus approximately 4 months' worth from your principal
• Penalty calculation: $10,000 at 5% APY with 6-month penalty = $10,000 x 0.05 x (6/12) = $250 penalty

Strategies to Minimize Penalty Impact

• Keep emergency funds separate: Always maintain 3-6 months of expenses in a liquid high-yield savings account before opening CDs
• Use a CD ladder: With CDs maturing regularly, you're less likely to need early withdrawal
• Consider no-penalty CDs: These allow withdrawal without penalty after an initial holding period (usually 7 days), though rates are typically 0.25-0.50% lower
• Match terms to your timeline: If you might need money in 8 months, don't lock it in a 12-month CD
• Partial withdrawals: Some banks allow partial early withdrawal, limiting the penalty to only the amount withdrawn

When Early Withdrawal Might Make Sense

In rare cases, paying the early withdrawal penalty can be the right choice:

• Rates have risen significantly: If you can earn 2% more on a new CD and you have 3+ years left on your term, breaking early and reinvesting at the higher rate may result in more total interest
• Better investment opportunity: If you need capital for a significantly higher-return investment
• Genuine emergency: The penalty is often less costly than credit card interest or other high-cost borrowing

Always calculate the total cost before making an early withdrawal. Our compound interest calculator can help you compare scenarios.

Choosing the Right CD Term: A Strategic Guide

Selecting the optimal CD term requires balancing several factors: your time horizon, the current interest rate environment, your liquidity needs, and the yield curve (how rates vary across different terms). Here's how to make the right choice.

CD Term Selection Matrix

Understanding the CD Yield Curve

The yield curve describes how CD rates vary across different terms. In a "normal" yield curve environment, longer-term CDs pay higher rates to compensate for locking up your money longer. However, in an "inverted" yield curve (common when the Federal Reserve is fighting inflation), short-term CDs may actually pay more than long-term CDs.

Check current CD rates at Bankrate or NerdWallet to see the current yield curve shape before choosing your term.

Term Selection by Interest Rate Outlook

• If rates are expected to fall: Lock in the longest term you're comfortable with at today's rates. A 5-year CD at 4.75% will look excellent if rates drop to 3% next year.
• If rates are expected to rise: Keep terms short (3-6 months) so you can reinvest at higher rates as they become available.
• If rates are stable: A CD ladder provides the best balance of yield and flexibility.
• If you're uncertain: Split your funds between short and long-term CDs, or use a barbell strategy (50% in short-term, 50% in long-term, nothing in the middle).

The "Break-Even" Calculation

When deciding between two CD terms with different rates, calculate how long it would take for the higher-rate option to "break even" against the lower-rate option if rates change. For example:

• Option A: 5-year CD at 4.50% APY
• Option B: 1-year CD at 4.75% APY, then reinvest annually

If rates fall to 3.50% after year one, Option A wins because you locked in the higher long-term rate. But if rates rise to 5.25% after year one, Option B wins because you can reinvest at the new higher rate. The break-even point is where both strategies produce equal returns—understanding this helps you make informed decisions based on your rate outlook.

Types of CDs

CDs vs. Other Savings Products

CDs are best when you want a guaranteed rate and won't need the money for a specific period. When rates are high and expected to fall, locking in a CD rate is advantageous. When rates are rising, a high-yield savings account lets you benefit from rate increases without being locked in. For a detailed breakdown of the differences, see our interest rate comparison guide.

When to Choose a CD

• You have a known time horizon: Saving for a down payment in 2 years? A 2-year CD locks in a rate with no risk.
• Interest rates are high: When rates peak, locking in a long-term CD preserves that rate even if rates drop later.
• You want zero risk: CDs are FDIC-insured up to $250,000. Your principal and agreed-upon interest are guaranteed.
• You're tempted to spend: The early withdrawal penalty creates a psychological barrier against spending your savings.
• Diversifying your savings: CDs complement stocks and bonds by providing guaranteed fixed-income returns.

Tax Considerations for CD Interest

CD interest is taxed as ordinary income in the year it's earned, even if you don't withdraw it. This means:

• Your bank will send a 1099-INT form if you earn more than $10 in interest
• Interest is taxed at your marginal tax rate (10-37% federally)
• State income taxes also apply in most states
• Consider holding CDs in a tax-advantaged account (IRA) if available

After-Tax CD Returns

A 5.00% CD yields only 3.40% after taxes for someone in the 32% bracket. When inflation is considered, the real (after-inflation, after-tax) return may be modest.

How CD Rates Have Changed Over Time

Understanding historical CD rates provides context for evaluating today's offerings. CD rates closely track the Federal Reserve's federal funds rate, which the Fed adjusts based on economic conditions.

Historical CD Rate Averages by Decade

The early 1980s were the golden age for CD investors, with rates exceeding 12% at some institutions. The 2010s represented the opposite extreme, with near-zero rates that barely kept pace with inflation. The current rate environment (2023-2026) offers a return to meaningful real yields for the first time in over a decade, making CDs a viable component of a conservative portfolio once again.

Rate Environment and CD Strategy

Your CD strategy should adapt to the rate environment. In a rising-rate environment, favor shorter-term CDs (3-6 months) so you can reinvest at higher rates as they become available. In a falling-rate environment, lock in the highest available rate with a longer-term CD (3-5 years) before rates decline further. In a stable-rate environment, a CD ladder provides the best balance of yield and flexibility.

Central bank policy announcements and inflation data are the two most reliable indicators of where CD rates are headed. When the Federal Reserve signals rate cuts, it is generally time to lock in longer-term CDs at current rates before they decline.

Building a CD Portfolio for Income

Retirees and conservative investors can build a CD portfolio that generates reliable monthly income while maintaining principal safety. The strategy combines multiple CDs with staggered maturity dates so that a portion of the portfolio matures each month.

For example, with $120,000, you could open twelve $10,000 CDs maturing one per month. As each CD matures, you either withdraw the interest as income and reinvest the principal, or reinvest the full amount at current rates. This approach provides monthly liquidity without early withdrawal penalties while maintaining exposure to competitive rates across different terms.

At a 4.75% APY, a $120,000 CD portfolio generates approximately $5,700 per year in interest income, or roughly $475 per month — all while preserving the original principal. Combined with Social Security and other retirement income, CD interest can meaningfully supplement a retiree's cash flow with minimal risk.

Brokered CDs vs. Bank CDs

Brokered CDs, purchased through brokerage accounts like Fidelity, Schwab, or Vanguard, offer several advantages over traditional bank CDs. They provide access to CDs from hundreds of banks through a single account, often with no early withdrawal penalty because you can sell them on the secondary market (though at a potential loss if rates have risen). Brokered CDs are also FDIC insured up to $250,000 per issuing bank, so you can achieve multi-bank FDIC coverage within one brokerage account. The compounding on brokered CDs works identically to bank CDs, but the added liquidity and diversification options make them worth considering for larger CD portfolios. One important difference: some brokered CDs pay interest semi-annually rather than monthly, which can slightly reduce the effective compound yield compared to a bank CD that compounds daily. Always confirm the compounding frequency and payment schedule before purchasing a brokered CD, and compare the stated APY against equivalent bank CD offerings.

FDIC and NCUA Insurance: Protecting Your CD Investment

One of the primary advantages of CDs is the federal insurance that protects your deposits. Understanding how this insurance works helps you maximize your protected savings.

FDIC Insurance for Bank CDs

The Federal Deposit Insurance Corporation (FDIC) insures deposits at member banks up to $250,000 per depositor, per institution, per ownership category. This means:

• Your principal and earned interest are guaranteed even if the bank fails
• Coverage is automatic — no enrollment required
• Joint accounts have separate coverage ($500,000 for a joint account)
• Retirement accounts (IRAs) have separate $250,000 coverage

NCUA Insurance for Credit Union CDs

If you open a CD at a credit union, it's insured by the National Credit Union Administration (NCUA) with identical $250,000 coverage limits. Credit union CDs (often called "share certificates") work the same way as bank CDs and offer competitive rates.

Maximizing Your Insured Coverage

If you have more than $250,000 to invest in CDs, you can maximize your FDIC coverage by:

• Using multiple banks: Each bank provides separate $250,000 coverage
• Using different ownership categories: Individual, joint, and retirement accounts each have separate coverage at the same bank
• Using brokered CDs: A single brokerage account can hold CDs from multiple banks, each with separate FDIC coverage
• Using CDARS/ICS networks: These services automatically spread large deposits across multiple banks for full FDIC coverage

Always verify that your bank or credit union is FDIC or NCUA insured before opening a CD. You can check a bank's status on the FDIC's BankFind tool.