What is Apy in Banking?

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"Annual percentage yield" is commonly abbreviated as "APY." It is a term that applies to almost all savings accounts and some checking accounts. The APY indicates how quickly your money will grow, with higher APYs resulting in faster growth. Understanding this term is crucial for individuals who prioritize saving more money.

APY stands for "annual percentage yield." It refers to the amount of money or interest earned on a bank account over one year. There are two types of interest - compound interest and simple interest - that can often be mistaken for each other. Compound interest includes the interest earned on the money you deposit into the account and the interest it accrues over time, while simple interest is only based on the principal amount in the account.

A higher APY is better for savings accounts, and many online banks offer APYs of around 2.00% and above, which is significantly higher than the national savings average of 0.35%. Online banks can offer higher APYs because they save on overhead costs that traditional brick-and-mortar banks have.

If you're willing to keep your savings deposited for a set period of time, consider a certificate of deposit (CD), which tends to have higher rates than high-yield savings accounts. Some online banks have 1-year CD rates around 3.25%.

Read More: What is Investment Banking

APR vs. APY: What’s the difference?

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APR and APY are two different terms that are often confused. Generally, APY refers to the interest you earn, while APR refers to the interest you pay.

APY is a percentage rate that reflects the total amount of interest earned on a deposit account or investment, based on the interest rate and compounding frequency over one year.

On the other hand, APR is a percentage rate that represents the cost of credit for a year, which means how much you pay annually to borrow money.

To earn more interest on your money, it's recommended to look for deposit accounts with high APYs. On the other hand, when it comes to loans, credit cards, and other borrowed money, it's ideal to look for low APRs. (You can learn more about APRs and personal loans.)

How to calculate APY

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To calculate APY, you can use a formula if you know your account's interest rate:

APY = (1 + r/n)^n - 1

Here, "r" represents the interest rate and "n" represents the number of compounding periods. For example, if the interest is compounded monthly, "n" would be 12.

Your bank or credit union can also provide you with your APY if you don't want to calculate it manually.

If you know your APY, you can easily determine how much you'll earn over a certain period of time using a compound interest calculator. You'll just need to input your starting balance, the amount you plan to add each month, the length of time, and the APY.

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How compound interest works

Compound interest occurs over a set period, typically daily or monthly. Daily compounding results in more money than monthly compounding.

While the difference is generally too small to be concerned about unless dealing with large sums, every little bit counts. For instance, if you have $100,000 in an account with a 2.00% APY, interest compounded daily would earn you $2,020.08 in a year. Comparatively, interest compounded monthly would earn $2,018.44, and interest compounded annually would earn $2,000. (You can learn more in our compound interest explainer.)

When looking for a new savings account or CD, it's important to prioritize finding a high APY. The higher the rate, the quicker your money will grow. Additionally, it may be worth checking how frequently the rate is compounded, as some accounts compound interest daily and can help you earn a little bit more.

Is APY variable?

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The type of savings account you have determines whether your APY is fixed or variable. If you have a regular savings account, the APY may fluctuate based on market conditions. In contrast, the APY on a CD typically remains fixed throughout the term, but if you sign up for a new CD later, you may receive a different rate.

Changes in the Federal Reserve's benchmark interest rate tend to affect APYs on savings accounts and new CDs. A decrease in the benchmark rate often results in a decrease in APYs, while an increase in the benchmark rate typically leads to an increase in APYs. However, online banks usually offer consistently high APYs regardless of the benchmark rate.

FAQ

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What is considered a good APY?

A good APY is typically higher than the national average savings rate of 0.35% APY. Some of the best savings rates are offered by online banks and can be around 2.00% or higher.

How do you calculate APY?

APY is calculated using a formula that takes into account the interest rate and the number of compounding periods in a year. The formula is: APY = (1 + r/n)^n - 1, where r is the interest rate and n is the number of compounding periods.

Is there an easy way to calculate how much interest I'll earn with my APY?

Yes, if you know your APY, you can use an online tool such as a compound interest calculator to quickly calculate the amount of interest you'll earn on your balance at that rate.

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Source: https://www.nerdwallet.com