APY and Compound Interest
APY (Annual Percentage Yield) shows actual return on savings including compound interest effects. 5% interest compounded monthly yields 5.12% APY because interest earns interest. Formula is (1 + rate/compounds)^compounds - 1. More frequent compounding increases APY - daily compounding yields slightly more than monthly at same interest rate.
Banks advertise APY for savings accounts and APR for loans - highest number in each case. Compare APY when choosing savings accounts, CDs, or money market accounts. 5% APY at Bank A is better than 5.1% interest rate compounded annually at Bank B (which is only 5.1% APY).
APY assumes you leave interest in account to compound. Withdrawing interest reduces actual yield. Maximum benefit from high-APY accounts requires patience - let compound interest work over time. Even small APY differences accumulate significantly over years on large balances.
Quick Tips
- Always compare APR, not just interest rates
- Use the Rule of 72 to estimate doubling time
- Extra payments dramatically reduce total interest
Frequently Asked Questions
APR is cost of borrowing (lower is better). APY is yield on savings (higher is better). APR doesn't compound, APY does. Banks use favorable calculation for their benefit - APR for loans, APY for savings.
Modest impact. Daily vs monthly compounding on 5% interest only differs by 0.02% APY. More significant on higher rates or larger balances. Still, choose daily compounding when available - it's free extra money.
Savings account APY is typically 0.5-5%. Stock market historically returns 10% annually but with volatility risk. Use high-APY savings for emergency funds and short-term goals. Invest for long-term growth with higher risk tolerance.