What is Annual Percentage Yield (APY)?
Annual percentage yield (APY) tells you how much you stand to earn or owe on an account in one year — including interest applied to your previous interest (compound interest).
Annual percentage yield tells you how much money an investment, such as a savings account or certificate of deposit (CD), can earn over one year. It includes interest you stand to earn on your initial contribution (principal), plus interest you’ll earn on the interest itself. APY will be higher than the annual interest rate if the account has compound interest (interest added to the principal at regular intervals). APY is useful when comparing different accounts to see where your money is working the hardest. The higher the APY, the higher the returns you can earn. However, it’s important to compare other factors too, such as account minimums, fees, and withdrawal limits.
As of November 2019, Capital One offers an annual interest rate of 1.7853% for its 360 Performance Savings Account. It compounds interest (adds interest to the principal) monthly. Let’s say you deposit $1,000. After a month, you’ll earn $1.43 in interest. Every month after that, your original deposit will earn interest, and the interest you’ve made will earn interest too. So in the second month, you’re now making money on $1,001.43. Your account balance would be $1,003.04 after two months, $1,004.47 after three, $1,005.90 after four, and so on. After one year, your savings account would have earned more than the simple interest rate of 1.7853%. Thanks to compounding, your savings account had an annual percentage yield of 1.80%.
Annual percentage yield is like planting apple seeds to get more apple trees…
An apple tree grows apples. Those apples can produce more apple trees, and those trees can, in turn, produce more apples. APY helps you calculate how many apples you will get at the end of a year.
An interest rate (also called the simple or nominal interest rate) is the cost of borrowing money. For instance, when you deposit money into a savings or checking account, the bank is borrowing from you. The interest rate is the percentage of your deposit — or principal — the bank pays you for lending it money.
Annual percentage rate (APR) refers to the interest you’ll owe on an account in a year, often including both interest and fees. You typically see APR advertised for loans and credit cards. APR can you give you a better idea of what you’ll actually owe than simple interest alone. (However, note that APR doesn’t always include all fees.)
One drawback of APR is that it doesn’t consider the effects of compounding. That means it doesn’t reflect what happens when you pay or earn interest on interest you accumulate, which can occur daily in some cases. On investments, compounding helps you make more money, while on a loan or credit card, it can increase what you owe.
Annual percentage yield (APY) does take compounding into account — It reflects the interest you earn not only on your initial investment but also on interest you earn over time. You may see APY advertised for a savings account or a certificate of deposit (CD) since financial institutions want to emphasize the maximum that you stand to earn. One limitation of APY is that it doesn’t take into account fees or charges your account may incur. In general, the APY will be higher than the APR on the same account, if it has compounding interest and low or no fees.
There are a few steps to calculating annual percentage yield:
Here’s an example of how to calculate Capital One’s 360 Performance Savings Account’s APY using its annual interest rate of 1.7853%.
The difference between APY and the annual interest rate may seem small, but it can add up over time.
It can be time-consuming to calculate APY by hand. Fortunately, online calculators will do it for you. If you type “APY calculator” in a search engine, you can find several options to choose from.
Please be advised that by searching for a third-party calculator, you’ll be accessing a third-party website. Robinhood Financial LLC is not implying that any monitoring is being done by Robinhood Financial LLC of any information contained on the third-party website. Robinhood Financial LLC is not responsible for the information contained on the third-party website or your use of or inability to use such site. Nor do we guarantee their accuracy and completeness.
When comparing savings accounts, a higher annual percentage yield will earn more interest. It’s essential to make sure that you are comparing apples to apples — or APY to APY. Some banks may also list the simple interest rate (also known as the advertised rate) or APR on their accounts.
You may not want to compare accounts based only on the advertised interest rates, because interest may compound at different frequencies. APY allows you to compare different accounts while taking into account compound interest.
According to the Federal Deposit Insurance Corporation (FDIC), the national average rate for a savings account as of November 2019 was 0.09% APY. A “good” APY may be one that is higher than average, although you may want to compare other account terms, such as fees, account minimums, and withdrawal limits.
Investors want their money to grow as much as possible in the shortest time. Annual percentage yield (APY) is a uniform way to measure which investment is the most profitable.
For example, let’s compare two hypothetical certificates of deposit. CD Option A offers a 5.0% interest rate compounded monthly. CD Option B offers a 5.0% interest rate compounded daily. Calculating the APY of each account can tell us which CD is more profitable.
CD Option B has a slightly higher APY than CD Option A because it compounds interest more often — 365 times instead of 12 times a year. With the higher APY, you can expect to earn a bit more interest with CD Option B.
The examples above are for illustrative purposes only and do not reflect the performance of any investment. Investing involves risk — You could lose your money.
When borrowing money, the annual percentage yield (APY) tells you the cost of accessing credit. The financial institution charges interest on how much money you borrow (the principal). Some credit cards charge interest on previously unpaid interest every day. Lenders and credit card companies often advertise annual percentage rate (APR) rather than APY. In reality, the APY is likely to be higher because of how frequently interest compounds.
Here’s an example of what happens if a financial institution quotes you APR. Depending on how often your account compounds interest — semi-annually, quarterly, monthly, or daily — you could actually be paying a much higher interest rate than advertised.
|Bank Quote||Compounded Semi-annually||Compounded Quarterly||Compounded Monthly||Compounded Daily|
Pay close attention when researching the interest rate you’re getting with your credit cards and loans. APY can give you a better idea of how much debt you can accumulate in one year, allowing you to make the most informed decision. The bottom line is that a high APY is great for investments, but you likely want a low APY for credit cards and loans.
What is Mutually Exclusive?
Mutually exclusive refers to the relationship between two or more events that cannot occur at the same time.
What are Articles of Incorporation?
A company’s articles of incorporation are a legal document that establishes a corporation and provides the government with relevant information to allow it to do business.
What is a Fund?
A fund is a pool of money dedicated to saving, investing, or virtually any other purpose either by an individual, a business, a government, or any other type of entity.
What are Liquid Assets?
Liquid assets don’t have anything to do with water: they’re ones that can quickly and easily turn into cash.
What is a Collateralized Loan Obligation (CLO)?
A collateralized loan obligation (CLO) is a sophisticated financial instrument in which investors receive a small portion of the payments from hundreds of business loans.