What is an APY and How Does It Work?
APY can give you an idea of how much you could earn in a year from a savings deposit.
APY, meaning Annual Percentage Yield, is the rate of interest earned on a savings or investment account in one year, and it includes compound interest. To help people compare accounts and get an accurate estimate of possible earnings, banks are required to prominently display account APYs.
Since APY tells you how much interest you earn on a deposit account over a single year, its accuracy depends on the account owner not adding or withdrawing any money from the account. So when you use APY to see how much interest an account will accrue, it’s important that you take your own account usage into consideration.
Is a high APY good?
Yes, when you’re comparing savings or investment accounts, a higher APY is what you want. The APY tells you exactly how much interest you can earn and counts how often the interest earned is compounded. It’s information that can help you determine which accounts will help you save more money, faster.
How do you calculate APY?
APY is calculated using what’s known as the APY formula. It looks like this:
Here’s how it works. The letter “r” is the interest rate, shown as a decimal, and “n” is how often the interest compounds. In our example, we’ll say the interest compounds monthly, so “n” will be 12. (If interest compounds daily, “n” would be 365.) We’ll make the interest rate 1%, and plug it into the formula as .01. That means:
APY = (1+.01/12)12 – 1
APY = 1.0008333333312 – 1
APY=1.01004596085 – 1
APY = .01004596085 or 1.004596% (1%)
What is compounding interest and how does it work?
Calculating APY reveals how much compounding impacts balances. Compound or compounding interest is commonly thought of as “interest on interest.” It’s calculated on the initial principal, including all the interest that principal accumulates each period. This is in contrast to simple interest, which is calculated only on the principal amount, not including additional accrued interest. Interest can be compounded at any set schedule including continuously, daily, monthly or annually. That frequency makes the difference in how much the initial principal will be impacted by interest.