The annual percentage yield (APY) refers to a number that shows the amount of interest a bank account like a certificate of deposit earns per year. If you check the interest rate on the savings account, you may see that it pays 0.02 percent or any number APY. Remember that annual percentage yield is associated with your interest rate, though they tend to differ. APY is the actual rate of return during a specific period on a savings, certificate of deposit, money market, or any other interest-earning account.
The annual percentage yield ensures that your money grows during the year because you can earn interest. Therefore, you usually earn more money than the interest rate on your account. You can use apy calculator to determine the amount of money you earned throughout the year. This article discusses what you need to know about APY.
Understanding APY
APY is usually a key feature you should consider when you decide to shop for a place to keep your savings. You should note that you can find some checking accounts that also pay interest. An APY can include the effect of compounding interest, meaning that you have both the accumulated interest earned and the principal. Compounding assists you money to grow quicker than simple interest which can pay interest only on the principal amount.
Take note that interest on your account can compound daily, monthly, quarterly, or even yearly. An account that compounds more frequently usually earns more money as the interest is added to the account regularly. This is the reason why you need to consider APY rather than looking at only the interest rate. You need to compare APYs so that you can find the best account that meets your needs.
Ideally, you can judge an investment by its rate of return regardless of whether it’s a share of stock, certificate of deposit, or a government bond. Remember that the rate of return is just the percentage of growth in investments over a specific period which is often a year. However, a rate of return can be hard to compare across various investments, especially if they have a different compounding period. One investment can compound daily while another may compound quarterly or annually.
Therefore, comparing rates of return by looking at the percentage value of each investment over one year can give inaccurate results. This is because it doesn’t consider the effects of compounding interest. You need to understand how often this compounding happens because the investment can grow faster when a deposit compounds more often. This is because every time you add the interest earned over this period to the principal as well as the future interest payments can be calculated on this larger principal amount.
Account APYs can differ significantly, but it depends on the bank and the product. For instance, the checking account with the high yields may pay more than 1 percent APY, but another checking account may pay nominal to zero interest.
The federal law known as the Truth in Savings requires financial institutions to disclose to clients the account APY as well as the frequency of compounding. You can find all the information on bank websites.
If you desire to figure out the amount of money you can earn on an account, you can utilize an APY calculator. For example, if you decide to deposit $1,000 into your savings account that provides 1.25% APY, and you intend to contribute $200 monthly for 2 years, then you can get $82.77 in interest. You can also have a bank balance of $5,882.77 after two years.
The difference between APY and APR
APY refers to the amount of interest you can earn on your account while APR is an annual percentage rate that stands for the annual cost for borrowing money. You should also note that the APR is a crucial consideration when you decide to shop for personal loans, credit cards, car loans, or home loans.
For instance, if you purchase a home, the lender can give you an appealing mortgage rate, though it’s the APR that can tell you the actual cost of the loan. This is because this percentage includes the interest, fees, and any points the lender may charge. Therefore, APR and APY are quite opposite because the APY can show you the amount you can earn by saving money. On the other hand, the APR shows the amount of money you can pay for borrowing money.
It’s also worth mentioning that APYs can be variable or fixed, but this depends on the kind of account you choose to open. For instance, a CD account can pay a fixed rate for a certain period like a year or five years. But checking and savings accounts pay variable APYs, meaning that the rate can fluctuate. And, the rate you can get once you sign up may rise and fall in the long run.
A crucial factor that can affect APRs and APYs is the federal funds rate. The Federal Reserve has been increasing the rate recently in an effort to control inflation. This may not be good for individuals who are looking to have a low APR on credit cards or other loans, but it’s great news for savers. This is because banks often increase the APYs once the Federal Reserve increases the benchmark rate.
Annual percentage yield tends to increase with frequent compounding periods. Therefore, if you want to save money in a bank account, then you need to know how often the interest compounds. It’s better to choose daily or quarterly compounding than annual compounding, though you also need to check the APY for any of the accounts just to be sure.
It also makes sense to consider your assets as part of your larger financial picture. This means that you should not take one CD investment as separate from the checking account. Instead, all investments must work together so that you can meet your goals, and you have to position them properly. You can maximize your personal APY by making sure that your cash is compounding frequently. If you have two CDs that pay the same interest rate, then you should choose the CD that pays out interest more regularly.