Bank accounts and Certificate of Deposits (CD’s) are very safe because the federal government insures them, usually up to $100,000. However, they normally pay relatively lower interest rates than bonds do. Also, sometimes bank accounts and CD’s cannot make enough money to stay ahead of inflation. CD’s usually pay a higher interest rate than bank accounts. But bank accounts are usually accessible while CD’s have a time period with a penalty for early withdrawal. CD’s have a fixed rate, but the rate goes up as the length of time increases. For example, a 2-year CD may pay 5% interest while a 3-month CD pays 4% interest.


Let’s review the math of putting money in bank accounts and CD’s.

I = P ´ r ´ t

where
I = interest
P = principal or present value (PV)
r = rate of interest (decimal)
t = time

Susan put $1,000 in a bank account at a 3% interest rate for 1 year. How much money from interest will she make in 1 year?

I = P ´ r ´ t
I = 1,000 ´ 0.03 ´ 1
I = 30 ´ 1
I = $30

Susan made $30 from interest in 1 year.

However, if inflation is 3.5% while Susan’s bank account is still giving her a 3% interest rate, Susan is losing 0.5% purchasing power this year. By putting money in a bank account, Susan loses $5 because of inflation.

Bob put $1,000 into CD’s at a 5% interest rate for 1 year. How much money will he make from interest in 1 year?

Estimate the answer:

Less than $30
Between $30 and $60
Over $60