If you’ve been researching different savings products, you’ve probably seen the term APY. If you’re confused, you’re not alone.
APY, or annual percentage yield, is the total amount of interest you will earn on savings accounts like a traditional savings account or a certificate of deposit in one year, including all compounded interest. APY is a good number to use when comparing savings accounts or CDs across – or even within – financial institutions.
Think about an interest rate as just one part of the big picture. It’s the money you can earn on your savings account's balance, expressed as a percentage. But it doesn’t tell you anything about how often your interest is compounded. That’s where the importance of the annual percentage yield comes in.
Two savings accounts with identical interest rates can end up with different APYs if the interest on one account compounds more often than the other. When interest compounds, it builds on itself. You essentially earn interest on your interest.
If you want to calculate how quickly your savings can grow (the fun part!), there are a few ways to do it:
Knowing how to calculate the APY can come in handy. It can help you understand how much interest you’d earn if, for example, the rate changes. This is important when you’re looking at savings accounts whose interest rates could change throughout the year – not just once.
To get started, use the following basic formula for APY: APY =(1+r/N)^N-1
APY = 100 (Interest/Principal)
For example, if you know that you will earn a 2.23% interest rate and your account compounds interest daily, like at Marcus, you can get the following: APY=(1+.0223/365)^365-1=2.25%
An Excel spreadsheet can be another option. Enter in your own data, then let the program do the math for you. To see what your APY would be, in a new spreadsheet enter:
Perform a quick search for “APY calculator,” and choose between either a product-specific calculator or a general APY calculator to run the numbers.
When you know how to calculate APY and understand how it works, you have a better idea of exactly how your money grows.
Bottom line, the higher the APY, the faster your cash will grow.
Just a quick side note: If you’re looking at savings accounts and CDs, forget about APR. APR, or annual percentage rate, is the yearly cost of borrowing money. But, just like you use APR to compare different loans, you can use APY to compare savings accounts or CDs.