What Is Annual Percentage Yield (APY)?

What Is Annual Percentage Yield (APY) and Why Does It Matter?

Jenius Bank Team12/1/2023 • Updated 11/19/2024

Annual Percentage Yield (APY) represents the interest your money earns in a savings account, including compound interest.Setting money aside and building your savings is a great way to increase your wealth. But that money should work for you. Choosing an account with a high Annual Percentage Yield (APY) could help you earn more on your savings, even when you’re not contributing to the account regularly. Here’s what you should know about APY and how it works when looking for a new savings account.

Key Takeaways

APY gives you a more accurate understanding of how much your savings may earn over time.
APY increases with more frequent compounding periods, so choosing an account that compounds daily rather than monthly may help you grow your wealth faster.
The amount you could earn varies across account types and banks.

What Is APY?

APY refers to the amount of money a deposit account earns in interest over the course of a year. It takes into consideration the rates on the account, as well as the compound interest earned on every dollar you keep in the account. The APY your account receives depends on the type of account you have, and the rates offered by your financial institution.

Account Type	Average APY
Checking accounts	Typically, 0% APY¹
Savings accounts	0.45%² APY (as of October 21, 2024)
High-yield savings accounts	5.00% - 5.50% APY³ (as of November 8, 2024)
Certificate of deposit (CD) accounts*	0.23% - 1.37% APY⁴ (as of November 1, 2024)
High-yield certificate of deposit accounts*	Up to 4.75% APY⁵ (as of November 8, 2024)
Money market deposit accounts	0.01% - 4.20% APY⁶ (as of November 2, 2024)

* Rate varies based on term

How Does APY Work?

As mentioned, APY considers the interest earned on an account and the frequency of compounding the account receives. This gives you a clearer understanding of how much money you could receive in interest over the year.So, what is compound interest? Compound interest accrues not only on the principal balance but also on the previously earned interest in the account. Essentially, you’re earning “interest on interest” each period… and that becomes the power of compounding.

APY vs. Interest Rate

Though APY and interest rates are related, they’re different creatures. Interest rates measure the return paid on your money over a certain time and only look at the interest paid on the principal amount deposited. APY considers the returns earned on the principal amount and considers compound interest. Think of the interest rate as a part of the greater APY calculation. Without the interest rate, you can’t calculate APY. And without an APY, you won’t have a clear picture of how much your savings could grow over the year.

Variable vs. Fixed APY

Your APY may be variable or fixed, depending on your account type. Variable APY rates change throughout the year based on market conditions, meaning if the average market rates go up for your type of account, your account’s APY should follow suit. If market rates go down, your APY drops. Accounts with fixed APY rates stay the same, no matter what the market is doing. Certificate of deposit (CD) accounts typically earn fixed rates while savings accounts, money market accounts, and other savings products tend to have variable APY rates.

APY vs. APR

Though they’re often confused, APY and the Annual Percentage Rate (APR) apply to different types of accounts. APY applies to deposit accounts like CDs, savings accounts, or money market deposit accounts and refers to how much you earn. APR pertains to the interest you owe on loans and lines of credit like your credit card. Like APY, the APR may be fixed or variable. Another difference between APY and APR is that APR factors in the fees charged for borrowing money, but APY doesn’t incorporate fees into its calculation.⁷Bottom line, APY is what you earn, a benefit to you and your savings. APR is a cost—the higher your APR, the more money you pay. That said, when debt is used strategically, like to invest in a home or your education, you may find that the cost of the APR is worth it in the long run.

How to Calculate APY

APY is a mathematical calculation. Here’s the formula:⁸APY = (1+r/n)ⁿ – 1In the equation, r refers to the interest rate and n refers to the number of compounding periods per year. Since financial institutions express their deposit account rates in APY, you’re not likely to ever calculate it yourself. However, to understand how the math works, let’s look at a hypothetical. Say you have $50,000 and a 5.00% interest rate that compounds monthly. Assume there is no change in interest rate for the period.To find the APY, input .05 as r, and 12 as n, i.e., for monthly.APY = (1+ .05/12)¹² – 1 APY = (1+.0041666)¹² – 1APY = (1.0041666)¹² – 1APY = 1.0511610 -1 APY = .0511610 or 5.12%This demonstrates how APY is mathematically different than just interest rate with the frequency of the compounding. If the account had compounded daily instead, n would have been 365. Imagine that! Back to the example, if this were your APY for a savings account, how much would you earn in a year? (Assume no withdrawals and a steady APY.) Multiply $50,000 by 5.12% APY, and the result is $2,560. If you want to calculate earnings beyond a year and/or incorporate other factors, a savings calculator may be helpful.

Comparing APY Between Accounts

If you’re considering switching to a new bank and are comparing APYs, here are some of the factors you should look for.

Compounding frequency: The more frequently the account compounds, the greater your potential returns because you earn interest on the interest accrued.
Fees: Some financial institutions charge fees for maintaining an account or making withdrawals, which may eat into your earnings. Be sure to check the terms for each account you’re considering.
Tiered APY rates: Some banks tie APY to the amount you have in the account, with larger amounts potentially earning higher rates.⁹ Be mindful of any tiers associated with an account before you open one.
Minimum balance requirements: Some banks have minimum balance requirements and may charge a fee if your balance drops below a certain amount, which could limit your interest earnings.
NCUA or FDIC insurance: As a rule, make sure to open accounts at an NCUA or FDIC-insured institution. FDIC insurance protects your money in the event of a bank failure up to $250,000 per depositor, per account type, per institution. That means you won’t lose your money if the bank goes under.

When you’re shopping for an account, you may also want to consider how the savings vehicle works. Do you want to “set it and forget it”? Or do you plan to make regular deposits to the account?Most savings account types let you continue adding money to the account after opening (think high-yield savings accounts). In that case, you’re actively helping to grow your nest egg over time. But CDs usually only allow a single deposit when you open the account. So, while a CD may still have compounding interest, you usually aren’t contributing to that base deposit to help spur overall growth. Both options are solid. The choice is all about how you want to manage your savings.

Final Thoughts

The APY you choose plays a strong role in the growth of your savings, and taking the time now to shop for a higher APY may help your savings grow faster in the long run. Make sure to open an account at a trustworthy, NCUA or FDIC-insured bank that also offers great rates to have the opportunity to achieve savings growth with even lower risk. Not sure where to start your search? Learn how to choose the right savings account and compare your options confidently.

Banking 101Saving & Checking

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