What is APY?
Annual percentage yield (APY) is the interest rate earned on an investment, savings, or checking account. That is, how much your investment will grow over a year, expressed as a percentage. This includes compound interest, which is calculated on a periodic basis, including daily, monthly, or quarterly. The interest amount gets added to the balance, or principal amount, immediately.
With compound interest, you gain interest not just on the principal amount (the initial amount you invest), but also on the interest generated later on. Simple interest is only calculated on the principal. Some of the banking products that offer an APY include checking accounts, traditional savings accounts, high-yield savings accounts, money market accounts, and certificates of deposit.
How are APR and APY different?
APY is often confused with APR. Simply put, APY is earned by an investor while APR is paid by the borrower. They are similar in that they are standardized. APY is the returns you get for your investment whereas APR is the interest you pay for loans borrowed. Both are calculated on a yearly basis, but APR does not take compound interest into account.
Why is an APY important?
Knowing the APY on any investment tells you the actual interest rates you will receive or pay. As an investor or borrower, this helps you decide which certificate of deposit, government bond, or stock share to invest in, which credit card or loan to apply for, or which bank to open a savings account in.
Online banks offer higher APYs than physical banks because they have fewer costs overall. As an investor, knowing the APY helps you compare each of the potential investments for their returns and make the best decision.
APYs often fluctuate based on the larger economy and policies. What may be a good APY now may not be the same later. Usually, if the Federal Reserve changes the interest rates, some of your investments and funds, like your savings account APY, also change. The interest rate on a certificate of deposit remains the same because it is active only for a set period of time.