Question on Certificates of Deposit

Alright. On a basic certificate of deposit. Let’s say that i put in $1000. Interest is added quarterly. Let’s say after one quarter i have $1050, does the next quarters interest take interest from 1000 or 1050?

Also, is it possible to live off of the interest earned from a CD? Obviously it’s possible, but what amount would be the minimum to live comfortably and not worry about inflation too much.

The interest accrued for the second quarter would be on $1050 at the actual interest rate. You may see two rates: the actual one and an annual percentage yield or rate (APY or APR). The beauty of compound interest (for savers) is that the APR will be larger than the nominal rate, depending on the frequency of compounding.

As to your second question, retirement planning worksheets tend to say that if you want to be able to live off a lump sum indefinitely (including the effects of inflation), you should withdraw no more than 4% each year. So if you want to spend $40k a year, you’d have to have an initial nest egg of at least one million dollars.

Here is a certificate of deposit calculator from bankrate.com.

Yes, you can live off the interest from a CD. But without knowing details, no answer is possible.

Did you mistype this? The APY is the larger of the two rates (APY and APR, which are distinct terms). Generally, when a bank is borrowing your money, they will quote the APY in order to make the offer seem that much more enticing, and when you are borrowing their money, they will give you the APR, for the same reason.

Here is a helpful article which explains this distinction in more depth.

You’re right, Rigamarole - and thanks for the informative article.

A better way to get a fixed income is an annuity. I think that if you are around 50ish, they are paying out around 5% per month. In other words, a $100,000 annuity pays you around $500/mo for the rest of your life.

Per month? I’m not familiar with the workings of annuities, but 5% of $100,000 is $5,000, not $500. Perhaps you meant 0.5%?

Ummm… $5000 PER YEAR. 5000 / 12 = $416.67.

J.

The real answer is that CDs will never beat inflation, which means that over time, your “real” return will be reduced – just because $100 today will by you more than $100 will buy you in 10, 20, or 30 years.

So you’d have to have significantly more invested in CDs so that you could plow some of that interest back in to your principle. Stock market investments, however, typically beat inflation by several percentage points. Putting money into an S&P 500 Index Fund would help you beat (or at least keep up with )inflation over the long term. This is the “conventional wisdom” regarding making your money last in retirement.

J.

My credit union offers 6 month CD’s with 4.25% rates, higher than the current rate of inflation (roughly 3.75% - 3.99%, depending on whose numbers you believe). You can get better rates than that if you want to go to 60-month ones, but the inflation rate is less predictable over five years.

Not to be too persnickety, but you have to consider your after-tax gain. Using the rule of thumb that you’ll lose about 1/3 to taxes, that 4.25% CD’s after-tax gain is only about 2.83%.

BTW, Etrade Bank has 90 day CDs at 5% interest.

J.

Emigrant Bank has online savings accounts at 5%. Why bother with CDs?

Well, Amtrust Direct has CDs at 5.41% APY. It’s a bit better.