WHAT IS APY?

11 June 4 MINS READ
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Banking, like every other issue in finance, has a plethora of acronyms. You've probably heard of the phrase APY if you've ever created a savings account, interest-bearing checking account, money market account, or certificate of deposit (CD).

So, how does the APY work?
Let's get started.

WHAT DOES APY MEAN?

APY is an acronym for Annual Percentage Yield. It is simply the amount an account pays you. It describes the returns you can receive on your savings, CD, or interest-bearing checking account. It calculates how much your balance will increase over a year if you leave it in your account. Because interest is paid as a percentage of your account balance, APY is always expressed in percentages.

HOW DOES APY WORK?

When interest is added to a principal sum invested or borrowed, and these sums compound, the APY effectively estimates how much money will be earned or charged. APY, in contrast to simple interest-based calculations, considers the benefits of compounding interest (which is calculated frequently) over time rather than using simple interest to determine the potential of your investment. Finally, APY gives you a more accurate picture of how much money you'll make.

A greater annual percentage yield (APY) means a faster-growing investment.

HOW TO CALCULATE APY

Get ready to do some maths.

Or maybe not. Most banks are required to publish APYs for their products, which they often do so you don't need to bother yourself with the maths. In any case, the following formula is used to calculate APY:


r denotes the yearly interest rate.

n is the annual compounding rate of interest.

LET'S DO SOME MATHS STILL...

If a person puts $1,000 in a savings account that earns 5% interest annually, he will end up with $1,050 at the end of the year.

The bank, on the other hand, could calculate and pay interest every month, leaving him with $1,051.6 at the end of the year. In the latter situation, he would have received an annual percentage yield of more than 5%. The difference may not be considerable at first, but it becomes important after a few years (or with greater deposits). In this case, APY is calculated as follows:

APY=(1+0.5/12)12-1= 0.0516 = 5.16%

The annual percentage yield (APY) can inform investors on how much interest they will receive. They can compare options using this knowledge. They will be able to choose which bank is the best and whether they should use it or not.

IS APY VARIABLE?

Depending on the kind of deposit account, the APY can be variable or fixed. The annual percentage yield (APY) on a savings or money market account is often variable. This indicates that it is linked to a base rate.

If the base rate rises or falls, your APY may rise or fall with it. Savings account rates are frequently affected by changes in the federal funds rate. Banks may reduce the APY provided to savers if the Federal Reserve lowers interest rates.

The annual percentage yield (APY) on CDs is usually fixed. A CD is a time deposit account, which means you commit to keeping your money in it for a specific amount of time. In exchange, you'll receive a set interest rate instead of a variable one until the CD matures.

If you opt to roll the CD over when it matures, the new rate you earn may move higher or lower depending on the base rate. However, there are some exceptions to this rule. Although this isn't usual for regular CD accounts, certain banks offer to raise your rate or bump-up CDs, which allow you to boost your rate and APY during your CD term.

APY VS APR

The amount of interest earned on your savings is referred to as the annual percentage yield (APY), while the amount of interest owed is referred to as the annual percentage rate (APR).

The interest rate on an account, plus any fees you'll have to pay, is referred to as the APR (Annual Percentage Rate). It is expressed as a percentage and is determined every year. Annual Percentage Yield (APY) is the rate you can earn on an account over a year, including compound interest.

You want the APR to be low because it will offer you an indication of the charges you'll incur with a credit card or loan. When looking for the best APR, look for the lowest number feasible, and make sure you see the typical APR, not just an example prefaced with the phrase "as low as." In the case of APY, you're interested in seeing how much interest you can earn from a potential account or investment. That means you'll want the annual percentage yield (APY) to be as high as possible.

In simple terms,

High APY = Good, Low APR = Also Good.

BOTTOM LINE

A high annual percentage yield (APY) can help you grow your investments significantly over time. The annual percentage yield (APY) varies greatly depending on the account and the bank. Comparing APYs might help you make the best financial decision if you're considering different investment options.

When picking a savings account, there are other aspects to consider besides APY, such as customer service and how easy it is to access your cash, but APY should undoubtedly be one of them. As the examples above demonstrate, it can make a significant difference in how quickly your savings increase.