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APY — which stands for annual percentage yield — is the percentage of your money that you can earn back in interest when you deposit it at a financial institution. Unlike APR, which shows how much interest you’ll pay annually for a credit card or loan , APY factors in compounding interest.
If you’re comparing savings accounts or money market accounts, choosing a financial institution with a competitive APY will maximize the interest you earn. In this article, we’ll explain what is APY and how to calculate APY.
What Is APY?
APY is short for annual percentage yield and shows how much interest you can earn when you deposit money at a bank or financial institution. Another term for APY is earned annual rate, or EAR. You’ll see APYs advertised when you compare rates for deposit accounts, such as:
The APY on most bank accounts is variable, meaning that it can change at any time. One exception is CDs, which typically pay a fixed rate until the CD reaches its maturity.
APYs are tied to the benchmark interest rates set by the Federal Reserve. If the Fed raises interest rates, most banks will pay more interest to stay competitive. But if the Fed lowers interest rates, your APY would drop.
How to Calculate APY
APY is calculated using the following formula:
A=P(1+[r/n])rt
A = Future value of both initial principal and interest earned
P = Initial principal amount, or beginning deposit
r = Annual interest rate, expressed as a decimal
n = Number of compounding periods in a year
t = Time in years
As an example, suppose you open a new high-yield savings account at an online bank that offers a 2% APY. You deposit $10,000 and don’t make any withdrawals or additional deposits for a year. Interest is compounded monthly. You’d calculate APY as follows:
$10,000(1+[0.02/12])0.02(1) = $10,201.84
What Is the Average APY?
The average APY varies by the type of deposit account. As of March 2022, the average savings account APY was 0.06%, though the best…
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