Interest calculations - help needed!

Thomask

I've got a question for a friend of mine. She wants to invest $50,000 and has the following options: 1/ Invests using 5 term investments each with $10,000 at 8.20%. The interest would be paid monthly and put into another account paying 7.40% (e.g. would not be compounded). Each investment would last 7 months. 2/ Invests using 5 term investments each with $10,000 at 8.20%. The interest would be paid at month 3, month 6 and month 7. After each interest payment, the money would be compounded back into the term investment until it matures (after 7th month). The question here is should she choose monthly interest payments, but earn only 7.40% on this interest, or choose interest payments after months 3, 6 and 7 but earn 8.20% until the 7 months are up? Thanks!

(this is for accounts overseas)

masonic

Is the 8.20% the annual return (and is it 8.2% after compounding in the second option)? What about the 7.40% - is it paid monthly or annually, and if monthly does the rate take into account compounding?

Thomask

Yes, 8.20% is the annual return.

The compounded interest in the second option would be earning 8.20%.

7.40% is paid monthly and all interested is compounded.

masonic

OK, so in option 1, you have gross rates of 8.20% (0.683% monthly, not compounded) and 7.16% (0.597% monthly).
In option 2, you have a gross rate of 7.96% (1.99% quarterly) and the second account is unused during the account term.

So, plugging those figures into a spreadsheet, in option 1 there's $331.67 interest earned per month from the 8.20% account, making a final balance of $2435 in the 7.40% account when the term account matures.

In option 2, there's $2355 earned when the account matures.

So, maybe surprisingly, it seems it's better to go with sweeping the money out into the lower paying account (if I haven't got my calculations wrong). I suspect what tips the scales in favour of that option is the fact that no interest is paid until the end of month 3 in option 2.

Thomask

Not sure I totally understand you?

Which option did you think was better?

masonic

Option 1 ($2435) seems to be better than option 2 ($2355).

Thomask

The rate in scenario 1 shouild be 8.10% not 8.20%!

My friend is looking to invest within the next 24 hours - would anybody mind doing the calculations again?


Which would be the best option?

masonic

A reduction of 0.1% is going to knock about $30 off the interest earned in option 1. It will still work out better.