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I am thinking about purchasing some (short term) CDs once I have some extra savings. However, I'm not sure whether it is actually more profitable to purchase CDs or keep the money in my high-yield savings account.

Currently, Ally's savings account is at 1.8% APY. They also offer 3, 6, and 12 month CDs at 0.75%, 1.0%, and 2.1% APY respectively. Given one year of time, the 12 month CD is obviously more profitable than one year of money in the savings account. However, I don't know how I would calculate the return with the other CD options.

Assuming all gains are kept in the savings account or included in the CD renewal and rates do not change. Given one year and $1,000 which is more profitable? What about over 5 years if the pattern continues?

  • Put all the money in the savings at 1.8% APY.
  • Purchase 3 month CD at beginning of the year and renew every 3 months.
  • Purchase 6 month CD and renew once it matures.

EDIT: In other words, what is the effective return for each of the three options?

  • The highest money market account that I know of is 2.10% and the highest three month CD is 2.0%. You can get a 3% in a three year CD. If it continues to be an increasing rate environment, I'd stick with the money market. You can Google for best rates. – Bob Baerker Aug 15 '18 at 17:27
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    Ally says what the APY values are, and you even wrote them in your question: "They also offer 3, 6, and 12 month CDs at 0.75%, 1.0%, and 2.1% APY respectively." So I'm having trouble understanding your question. – RonJohn Aug 15 '18 at 19:42
  • @RonJohn Those APY values assume that the CDs are only used once for the year correct? Or are they assuming that you renew the CD to fill up the whole year? e.g., do I get the 0.75% return for a given year if I only buy a single 3 month CD and don't renew (and thus have 9 months of no investment) or do I get 0.75% if I renew the CD every 3 months for the whole year? – Nosjack Aug 15 '18 at 20:08
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    @Nosjack - APY is the annual interest rate, meaning how much you would earn if the money was in place for 12 months. It's not how much you earn for the period of duration of the CD. The APY's are directly relatable, so the 1.8% APY on the savings account is better than the 0.75% and 1.0% APY on the 3 and 6 month CDs. – BobbyScon Aug 15 '18 at 20:28
  • APY means Annual Percentage Yield. If you hold an instrument with a 0.75% APY for 1/4 of a year, you'll get (roughly) 1/4 of 0.75% in that 1/4 of a year. – RonJohn Aug 15 '18 at 20:46
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In all four cases, the APY (Annual Percentage Yield) tells you exactly how much interest you can expect over the year, meaning that it takes compounding into effect. In essence, the interest rate for each period (3-month, 6-month) is back-calculated such that the actual yield for a year is the APY.

So if rates do not change, and you start with $100,000, then the 3-month CD (renewed after every 3 months at the same rate) will earn you $750 in interest (0.75%), the 6-month CD (renewed after 6 months at the same rate) will earn you $1,000 (1.0%), and the 12-month CD will earn you $2,100 (2.1%).

If instead you were quoted APR (Annual Percentage Rate), then you'd have to calculate the effect of compounding, meaning your 3-month CD would earn $187.50 (0.1875%) in interest over the three months, 187.85 the next 3 months (since you'd earn interest on the first $187.), and so on, for a net return of 0.752%.

  • It appears I was simply confused about how the APY is applied - cue flashbacks to engineering economics... Expanding the question to include a 3 year CD at 2.5% APY, I would expect the total return after 3 years to be 0.025 x 3 = 7.5% correct? – Nosjack Aug 16 '18 at 13:04
  • @Nosjack correct. – D Stanley Aug 16 '18 at 13:24
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The answer by D Stanley gives the basic math. But you asked for specific amounts.

Assuming all gains are kept in the savings account or included in the CD renewal and rates do not change. Given one year and $1,000 which is more profitable? What about over 5 years if the pattern continues?

Taking the APY for the CDs and the savings account, and looking at $1,000 for one year and renewing as appropriate.

- One  1 Year  CD: 1000 * 0.0210 or 21.00 in interest
- Two  6 month CD: 1000 * 0.0100 or 10.00 in interest
- Four 3 month CD: 1000 * 0.0075 or  7.50 in interest
- Savings Account: 1000 * 0.0180 or 18.00 in interest

If the rates didn't move for 5 years then after 5 years taking into account compounding you would have:

- Five   1 Year  CD: 1000 * (1.0210) ^ 5 or 109.50 in interest
- Ten    6 month CD: 1000 * (1.0100) ^ 5 or  51.01 in interest
- Twenty 3 month CD: 1000 * (1.0075) * 5 or  38.07 in interest
- Savings Account  : 1000 * (1.0180) * 5 or  93.30 in interest

But that is a big assumption. If rates stay the same that is what you will receive. The Savings account gives the most flexibility because you can get to the money without penalty at any time. It also has risk becasue the bank can change the rate at any time, while for you the CD rates only change at renewal.

If rates rise over the 5 years it is possible that the savings account rates will also go up. If that is the environment then the CD rates will also rise during that time. Having three month CD will allow you to catch the rising rates quicker but the rates would have to go up significantly to catch up with the 1 year CD or the Savings account.

Some people ladder their CDs. They structure them so that they end up with four 1 year CDs staggered by 3 months. They buy shorter term CDs in the beginning or buy them every three months depending on their cash availability and the rates of savings account in their bank. This catches rising rates or can extends better rates when overall rates are dropping. But if you need all the money at once, then you may face penalties that will reduce or eliminate the advantages of the CDs.

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As the way things stand, the 1 year CD will net you about $30 extra for each 10K in balance you hold. However, keep in mind that interest rates could rise. What did your Ally account pay 3 or 6 months ago? Probably on the order of 1.2% and 1.5%.

It is quite possible that the CD will be a worse deal. Interest rates could rise dramatically and your Ally account could be paying more, even much more, than the CD you cite.

Also as Bob points out, you could change account providers and up the rates for both the CDs and money market/savings account. One person reported today getting 1 year Tbills for 2.45%.

It is all speculation and opinion based which is why I will vote to close this question.

  • I'm more interested in the math to calculate the effective interest rate for each option over a year. Assuming that rates do not change. – Nosjack Aug 15 '18 at 18:53

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