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Account APY: What It Is and Why It Matters
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. When you choose an account with a high Annual Percentage Yield (APY) it could help you earn more on your savings, even when you’re not contributing to the account regularly.
When it’s time to look for a new savings account, here’s what you should know about APY and how it works.
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 Annual Percentage Yield (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%¹ |
Savings accounts | 0.46%² APY (as of October 16, 2023) |
High-yield savings accounts | 4.00% - 5.00% APY³ |
Certificate of deposit (CD) accounts* | Average as of October 27, 2023: 1.14% - 1.55% APY⁴ |
High-yield Certificate of deposit accounts* | 5.50% - 5.83% APY⁵ as of October 27, 2023 |
Money market deposit accounts | 3.45% APY⁶ |
* Rate varies based on term
How Does APY Work?
As mentioned, APY takes the interest earned on an account as well as the frequency of compounding the account receives into consideration. 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.⁷
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 takes compound interest into consideration.
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 the type of account you have. 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 refers to the interest you owe on loans and lines of credit. Like APY, the APR may be fixed or variable.
Another difference between APY and APR is that APR accounts for fees that go into borrowing money but APY doesn’t take any account fees into consideration.⁸
Think of APY as something that benefits you and your savings and APR as something that benefits your lender. The higher your APR is, the more money your lender gets from you, whereas the higher your APY, the more money you get from your bank.
Calculating APY
There’s a simple formula for calculating your APY⁹:
APY = (1+r/n)n – 1
R refers to the rate the account earns, and N refers to the number of compounding periods per year.
Let’s look at an example. Say you open a savings account and deposit $50,000. The account has a rate of 5.00% APY and compounds monthly. For this example, we’re assuming the rate remains steady for the year.
To find the APY for your new savings account, input .05 as r, the interest the account earns, and 12 as n, the number of times the rate compounds per year.
APY = (1+ .05/12)12 - 1
APY = (1.00416)12 – 1
APY = (1.051162) – 1
APY = .051162 or 5.12%
Now that you know your APY, multiply it by the amount in your savings account to determine how much interest you would earn in a year, assuming your rate stays steady at 5.00% APY. When you multiply $50,000 by 5.12% APY, the result is $2,558.10.
If you’d rather not do the math out by hand, you could always use a savings calculator to determine how much your savings will earn.
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. Remember, you earn interest on the interest that accrues so the more often your money compounds, the more you could earn.
Ability to Add Funds: Some deposit accounts, like most CDs, only allow you to make a single deposit when you open the account. Savings accounts, on the other hand, let you continue adding money to the account, which may further increase your returns over time.
Fees: Some financial institutions charge fees for maintaining an account or making withdrawals, which may eat into your balance. 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.¹⁰ Be mindful of any tiers associated with the accounts 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.
As a general rule make sure to open accounts at an 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.
Final Thoughts
APY is a great way to predict future returns on your savings and choosing a higher APY may help your savings grow faster. Make sure to open an account at a bank that’s trustworthy, offers great rates, and is FDIC-insured.
Not sure where to start your search? Learn how to choose the right savings account and start comparing your options with confidence.