The annual percentage yield, or APY, represents what you’ll earn in a year on an account that pays interest, like a savings account, certificate of deposit or money-market account. The higher the APY, the faster your money grows. Read on to learn more about yields and how they work.
What is an APY?
When comparing savings accounts, CDs or money market accounts, APY is a key factor to consider — because the higher the yield, the more you can earn in interest. And an APY tells you more than an interest rate, because it takes into account compound interest, a mechanism whereby you earn interest on interest you’ve earned previously. If you earn $5 on your $500 balance today, for example, compounding interest takes advantage of the fact that you’ll earn interest on $505 tomorrow.
Banks may offer accounts that compound daily, monthly, quarterly or annually — but it may vary from account to account. High-yield savings accounts and money-market accounts tend to compound daily or monthly. A traditional CD typically delivers interest in a lump sum at the end of the term. If you get a 5-year CD, interest is paid once your CD reaches maturity.
What’s the difference between a fixed and variable APY?
Unlike a fixed APY, a variable APY fluctuates as interest rates change. If the Federal Reserve raises rates, APYs often follow. Likewise, when rates decrease, APYs go down. This applies to savings and checking accounts as well as CDs, though those are more likely to have a fixed interest rate of return.
How to calculate APY
Here’s the formula for calculating the annual percentage yield:
APY = [1+ (i/n]^n – 1
- i = interest rate, expressed as a decimal
- n = number of times the interest is compounded. If quarterly, it compounds 4 times. If monthly, it compounds 12 times.
If you deposit $1,000 for one year at a 3% interest rate, and it compounds quarterly, you will have $1,030.33 at the end of the year.
- (1+.03/4) ^4-1= .03034 = 3.034%
- $1000 (1+.03/4) ^4-1 = $1,030.33
How is an APY different from an APR?
An APR, or annual percentage rate, typically applies to financial arrangements where you are borrowing money or using credit. You’ll often see an APR quoted for a loan or credit card, and the lower the rate, the less you will pay in interest. In contrast, an APY applies to financial arrangements where you deposit funds and earn interest.
How is an APY different from an interest rate?
Interest is the percentage of a loan you’ll pay to a lender to borrow money. When you take out a mortgage and start making payments, interest is included in your monthly payments. Interest rates are based on a handful of factors, such as inflation, market trends and your credit score. While interest rates measure how much interest you’ll accrue on a loan, APY reflects the interest you’ll earn for depositing money into a savings account.
How do I find the best APY?
What makes for a “good” APY depends on the specific product and wider economic conditions. A good APY for a 5-year CD will be different than it is for a savings account, and it’s changed considerably since last year, when interest rates were at historic lows. That noted, when it comes to savings accounts and CDs, online banks often provide higher APYs than national banks.
Can I change my account’s APY?
No, you can’t. Banks and financial institutions establish the interest rates and yields attached to their products and services. But you can comparison shop for accounts that offer higher APYs and move your money into them.
The bottom line
The APY is the interest you earn for depositing your money into savings accounts, CDs and money market accounts. It’s distinct from an interest rate, which is a reflection of the cost you’ll pay to borrow money, and from an APR, which includes all the costs of borrowing money.