APY or annual percentage yield is the total amount of interest you can expect to earn on your deposits over a 12-month period, with compounding interest.
You’ve likely come across the term APY when shopping for savings accounts. And depending on the type of account, you may have noticed that APYs can be fixed or variable. For instance, many certificate of deposit (CD) accounts offer a fixed rate while traditional savings accounts usually have a variable rate.
The APY rate can also vary across banks and different types of savings products – some offering a higher APY than others. Generally speaking, the higher the APY, the more you could earn on your money.
Let’s take a closer look at how APY works.
Some people often use the terms “APY” and “interest rate” interchangeably. While both are expressed as a percentage, there is an important distinction.
The interest rate doesn’t take into account the effect of compound interest. That’s where APY comes in: The APY reflects the effect of compound interest, which, in simplest terms, is the interest you earn on top of the interest you’ve accrued from your original deposit.
This is why two savings accounts could have the same interest rate but end up with different APYs if the interest on one account compounds more often than the other.
In short, APY is an important number to pay attention to when comparing savings products. It could help ensure you’re getting a competitive rate.
Good to know: Not every bank or account compounds interest at the same frequency. Interest can compound daily, monthly, or annually as determined by your bank. The key thing to remember is that the more often it compounds, the faster your money could grow. You can read more about compound interest in our article here.
An easy way to calculate APY is with an online APY calculator. But for those who are curious, here’s the formula:
r = interest rate
n = number of times the interest compounds during the year
So for example, if a savings account pays an interest rate of 2.23% and your account compounds interest daily, using the formula where r = 2.23% and n = 365:
APY = (1+.0223/365)^365 – 1 = 2.25%
Don’t confuse APY with APR. While both are related to interest rates, they’re not the same thing.
Read more: APR vs. APY
To help you get the best APY, you’ll want to do some comparison shopping to see what the current rates are across different banks for the savings products you’re interested in. When comparing savings accounts, with all other things being equal – the higher the APY, the more you could earn.
Keep in mind that some accounts (like many CDs) offer a fixed APY, allowing you to lock in a rate for a set term. Other accounts, like a basic savings account, come with a variable APY, which means the rate can go up or down based on market conditions.
Good to know: When the Federal Reserve raises the federal funds rate, banks tend to increase the interest rates they offer on deposit accounts. On the other hand, if the Fed cuts rates, banks tend to lower their interest rates as well. Read more here.
Certain types of savings accounts will have a higher APY than others. For instance, CDs typically pay a higher rate than a traditional savings account. The trade-off for the higher rate, however, is that your cash is locked up for a predetermined period of time (i.e., the CD term), and early withdrawals can result in a penalty (unless it’s a no-penalty CD).
Even for CD products, you’ll notice a variety of APYs offered across different terms.
Read more: Guide to CDs and Guide to Savings Accounts
This article is for informational purposes only and is not a substitute for individualized professional advice. Articles on this website were commissioned and approved by Marcus by Goldman Sachs®, but may not reflect the institutional opinions of The Goldman Sachs Group, Inc., Goldman Sachs Bank USA, Goldman Sachs & Co. LLC or any of their affiliates, subsidiaries or divisions. Information and opinions expressed in this article are as of the date of this material only and subject to change without notice.
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