What is compounded interest?
Compounded interest is interest that is added back to the principal of the certificate of deposit so that it can earn additional interest during the next compounding period. For example, a one-year certificate for $1,000 at 3.0% simple interest, that is interest paid at the end of the year only, would earn $30.00. A one-year certificate that compounds interest monthly would earn $30.43 for the year. For this certificate, the APR is 3.0% and the APY is 3.04%. The formula for calculating interest is (PxR)xT, principal times the rate times the time factor. The simple interest example above is calculated $1,000 x 3.0% x 1 (one year) = $30.00. The compounding interest example is more complicated because the monthly interest must be calculated and added to the balance and then the new balance used for the principal in the next months calculation. If the certificate was purchased on January 1, the interest at the end of January is calculated using this formula: $1,000 x 3.0%/365 x 31 = $2.55.
