APY and interest are terms frequently heard when discussing deposit products, like savings accounts and certificates of deposit (also known as CDs).
And while APY and interest are related, they’re not interchangeable. When it comes down to it, what you want to look for is APY.
First, let’s talk about interest. When you deposit money into an account with a bank, the bank doesn’t just hold onto the money for you; it can lend it out to others. In return, the bank pays you money. The money that a bank pays to you is interest.
The interest rates on savings accounts and CDs can change and are partly affected by what the Federal Reserve is doing. Generally when the Fed raises the federal funds rate, interest rates on savings accounts may increase. The opposite may also happen to interest rates when the fed funds rate decrease.
Rates on CDs may also change. But when you open a CD, the rate for that CD is typically fixed for the entire term.
So now you understand interest. Let’s throw another term at you.
APY stands for “annual percentage yield,” which is the amount of interest, shown as a percentage, you will earn if you keep your money in a savings account or CD for a year.
APY takes into account not only interest but also the rate at which it compounds. With compounding interest, you earn interest over set intervals of time and the interest you earn is added to the balance. In effect, over each new compounding period you earn interest on the interest you’ve already earned. The more often your money compounds, the more you can earn.
Interest typically compounds daily, monthly, quarterly or annually. This is an important point, so if you don’t know how often the interest compounds on your account, check out the small print.
Still with us? Good. Because here’s where things get really interesting.
If you’re shopping for a savings account or CD, you might look only at the interest rate. The higher the rate the better, right? But there’s actually more to it. Interest rates alone don’t give you the entire picture. You also need to look at how frequently the interest compounds, because the frequency helps determine how much money you could earn.
Here’s what we mean:
Do you see it?
In this instance, everything seems almost identical — the term, interest rate and initial deposit are exactly the same. But the outcome is different: You earn about $10 less if you go with the account that compounds interest annually. Because of this, since it takes compounding interest into account, what you should really be looking at is the APY.
Because APY is important, many banks take that number and display it in big print on their websites or advertisements. If you can’t find it, check the fine print.
And if you’re looking for a high-yield savings account or CD, Marcus by Goldman Sachs® has you covered. Our competitive interest rates compound daily.
And now you know why that’s a good thing.