- Annual Percentage Yield (APY) is the rate of return you earn over a year on deposit accounts, such as CDs, savings, and checking.
- The APY can be fixed or variable and includes compound interest, so you earn interest on your original balance plus any previously earned interest.
- The APY on a deposit account changes based on whether the economy is doing well and when the Federal Reserve raises interest rates.
There are many ways to invest your money to earn more. Invest in the stock market it’s a way to build wealth over time, but it’s not for everyone. Some prefer to take a more conservative approach and earn money through deposit accounts that offer an APY, or Annual Percentage Yield.
What is an annual percentage yield?
An APY is what you’ll earn in interest on a deposit account over the course of a year. It is common for consumers to earn APY through deposit accounts such as keeping accounts, Deposit certificates (DC), and money market accounts. An APY is always expressed as a percentage and is what you will earn on the funds you keep in your account throughout the year.
“Usually the investment is supposed to be held for 365 days,” says Laura Lonie, CPA and financial advisor at Laura J. Lonie LLC. Lonie adds that this is helpful when consumers are comparing multiple CDs or deposit accounts, as they can better understand what they can earn for their money without having to calculate the interest themselves.
Use Personal Finance Insider’s compound interest calculator to see how much your money can grow
Your balance after 5 years
How does APY work?
APY calculates the total amount of interest earned on an account over the course of a year. It includes your interest rate and your compound interest, or what you earn on the principal amount plus interest on your earnings.
“A savings account held for one year at a lower interest rate than one held for two years may have a higher amount of interest earned because the interest is compounded more frequently in the one-year term account,” Lonie says. . “Because APY annualizes investment, a consumer can compare APYs even though they have different holding periods and interest may be compounded differently, such as quarterly or monthly.”
You may see APY on products like savings, checking, CDs, and
. All of these are considered deposit-type investment accounts.
How to calculate APY
To get a better idea of how APY works, let’s take an example. Here is the formula for APY:
Say, for example, you put $1,000 into a 12-month CD that offers 5% APY, compounded monthly.
Using the equation above, here’s the breakdown:
(1 + 0.05÷12)12 – one
(1.0041666666667)12 – one
1.05116 – 1
$1,000 x 5.116% = $51.16 total interest earned.
The total amount in the account at the end of the year is $1,051.16.
Is APY variable?
The type of APY you have depends on the financial product you have, although many offer fixed APY. Some products, like CDs, offer fixed APYs, while savings accounts have variable APYs.
Any account with a variable APY generally sees rates go up and down with market interest rates. So when the Federal Reserve go up or down your target interest rateVariable rate accounts typically follow.
“APY can be fixed or variable, but most savings and
are variable,” says Lonie. “Interest rates change based on the economy and the actions of the
. Certificates of deposit have a fixed interest rate for a specified period.
APY versus interest rate
APY and interest rates overlap a bit, but they are different. While the APY represents what you can earn on a deposit account, the interest rate itself typically represents what you’re charged for a car loan, credit card, or mortgage.
“The interest rate does not take into effect compound interest, and the APY includes
Lonie says. “The interest rate is typically used for loans and APY for deposit accounts.”
An exception to interest rates that represent what you will owe when paying back a loan are captivity. These are debt securities that often offer an interest rate, commonly known as a coupon payment, that represents how much you’ll get back each year until the bond matures.
APY vs. APR
Both APY and APR they use interest rates in their calculations, but APY uses compound interest, where you earn interest on the principal amount and earnings. APR does not have that.
“APY includes interest earned on interest, while APR uses the simple interest method,” says Lonie. “APY is generally used for deposit-type accounts and APR for loans or credit cards.”
The bottom line
Using an APY is one of the best ways to determine your total return on a deposited account, such as savings or money market. The higher the APY, the higher the yield. Use this when looking for products that show APY.