APY explained: how savings interest grows
In short: APY (annual percentage yield) is the interest you earn in a year on savings, including the effect of compounding, where interest earns interest. Banks must show the APY, so it is the fairest number for comparing savings accounts and CDs. Rates on savings accounts can change at any time.
APY vs interest rate
The interest rate is the basic yearly rate. Interest is usually added to your account monthly or daily, and then that interest also starts earning interest. The APY includes this effect, so it is slightly higher than the rate whenever interest compounds more than once a year.
The formula is: APY = (1 + rate ÷ n)n − 1, where n is how many times a year interest is added.
A worked example
Put $1,000 in an account paying 4.00% interest, added monthly, and add nothing else:
- Each month earns 4.00% ÷ 12 = 0.333% of the balance.
- After a year you have about $1,040.74, not $1,040.00.
- So the APY is about 4.07%.
Figures are rounded and for illustration only.
APY vs APR
They sound alike but point in opposite directions. APY is what you earn on savings; APR is what you pay to borrow. See What is APR?
Comparing savings accounts
- Compare APYs, not interest rates or headline claims.
- Check whether the rate is a short introductory offer that drops later, or only applies above or below a certain balance.
- Look at monthly fees and minimum balances. A $5 monthly fee wipes out the interest on a small balance.
- Check that the bank is FDIC-insured or the credit union NCUA-insured.
Why small differences add up
Over many years, compounding makes a real difference. The free compound interest calculator on Investor.gov (listed below) lets you try different amounts, rates and years. Interest you earn is usually taxable income; ask a tax professional how it applies to you.
Handy tools
- Monthly budget planner: see what is left each month and how your spending splits up.
General information, not financial advice. Rules, fees and rates change and depend on your situation. Check with your bank, the provider or a qualified professional before you decide.
Sources
- Investor.gov (SEC): Compound interest calculator
- eCFR: 12 CFR part 1030 (Regulation DD, Truth in Savings)
- CFPB: Bank accounts
- FDIC: Understanding deposit insurance