Key takeaway
APY is the apples-to-apples comparison because it includes the effect of compounding.
APY stands for Annual Percentage Yield
APY, or Annual Percentage Yield, is the total amount of interest you earn on a deposit account in one year, expressed as a percentage of the principal balance. Unlike APR (Annual Percentage Rate), APY includes the effect of compounding—meaning it accounts for interest earned on both your original principal and the interest that accumulates over time.
APY is the most accurate way to compare different savings accounts, CDs, or other deposit products because it tells you what your money will actually earn in a year.
How APY is different from APR
APR and APY are both annual rates, but they measure different things:
- APR (Annual Percentage Rate): The simple interest rate without compounding. It tells you the percentage of principal you'd earn in a year if interest was only calculated once.
- APY (Annual Percentage Yield): The effective annual rate including compounding. It tells you what you actually earn when interest is added to your balance periodically (monthly, daily, etc.).
For example, a savings account with a 5% APR that compounds monthly would have an APY of about 5.12%. The APY is higher because you earn interest on the interest that accumulates each month.
How to calculate APY
The formula for APY is:
APY = (1 + r/n)^n - 1
Where:
- r is the annual interest rate (APR) as a decimal
- n is the number of compounding periods per year
For example:
- 5% APR compounded monthly: (1 + 0.05/12)^12 - 1 ≈ 5.12% APY
- 5% APR compounded daily: (1 + 0.05/365)^365 - 1 ≈ 5.13% APY
- 5% APR compounded annually: (1 + 0.05/1)^1 - 1 = 5.00% APY
The more frequent the compounding, the higher the APY will be for the same APR.
Why compounding frequency matters
Compounding frequency affects how quickly your money grows. With more frequent compounding:
- Daily compounding: Interest is calculated and added to your balance every day. This is common for high-yield savings accounts.
- Monthly compounding: Interest is calculated and added once per month. This is common for many savings accounts and CDs.
- Quarterly or annual compounding: Less frequent for deposit accounts, but sometimes used for certain products.
Daily compounding is slightly better than monthly, which is slightly better than annual—but the difference is usually small for typical interest rates. What matters more is the APY itself, because it already includes the effect of whatever compounding frequency is used.
APY for savings accounts and CDs
When comparing savings products, APY is the number you should focus on:
- High-yield savings accounts: Usually advertise their APY prominently because it's the main selling point. The APY can change over time as interest rates move.
- Certificates of Deposit (CDs): Usually have a fixed APY for the term of the CD. The APY is locked in, so you know exactly what you'll earn if you keep the CD until maturity.
- Money market accounts: Similar to savings accounts but sometimes with slightly different requirements for the best APY.
Always compare APYs rather than APRs when shopping for deposit accounts, because APY is the apples-to-apples comparison of what you'll actually earn.
APY vs APY earned
Sometimes you'll see two numbers: the stated APY and the "APY earned." The difference is:
- Stated APY: The rate the account offers if you keep your money in it for a full year and meet all requirements (like minimum balance or direct deposit).
- APY earned: The actual rate you earned in a given period, which might be different if you made deposits or withdrawals, or if rates changed during the year.
The stated APY is what you use to compare accounts; the APY earned is what you actually got in practice.
How APY works with tiered rates
Many savings accounts have tiered APYs, meaning you earn a different rate depending on your balance:
- A lower APY for balances under $10,000
- A higher APY for balances between $10,000 and $50,000
- An even higher APY for balances over $50,000
Sometimes these tiers apply to your entire balance, and sometimes only the portion above the threshold earns the higher rate (like tax brackets). It's worth checking which structure the account uses.
APY for loans and credit cards (usually not)
APY is typically used for deposit accounts where you earn interest. For loans and credit cards where you pay interest, you usually see APR instead.
That said, you can think of the effective cost of debt as similar to APY—because interest compounds on credit cards if you carry a balance, the actual cost can be higher than the stated APR.
What APY doesn't tell you
APY tells you the interest rate, but it doesn't tell you everything about an account:
- Fees: Monthly maintenance fees, overdraft fees, or other charges can eat into your earnings even if the APY is high.
- Minimum balance requirements: Some accounts require a minimum balance to earn the advertised APY.
- Access to your money: Savings accounts usually limit the number of withdrawals you can make per month.
- Whether the rate is fixed or variable: High-yield savings accounts usually have variable APYs that can change; CDs usually have fixed APYs.
The APY is important, but it's only one factor to consider when choosing an account.
APY helps you compare apples to apples
The beauty of APY is that it standardizes the comparison across different accounts with different compounding frequencies. You don't have to do the math yourself—you can just look at the APY and know which account will give you a better return, assuming you keep your money in it for a year.
When choosing where to park your savings, start with the APY, then consider the other features like fees, access, and minimums to find the account that fits your needs.
Related next steps
Use the APY Calculator to see how different rates and compounding frequencies affect your earnings, then try the CD Calculator to compare CD terms. If you're saving for a goal, check the Savings Goal Calculator to see how APY affects your timeline.