Key insights:
- Annual percentage yield (APY) measures the total amount of interest earned on an account in 1 year
- This calculation includes compound interest to give you a clear picture of your potential earnings
- While interest rates only reflect the base rate, APY factors in how often that interest compounds
- Comparing APY rates across savings account products could help you maximize your savings over time
If you’re looking to grow your money, annual percentage yield (APY) is a term worth knowing. An APY shows how much you can earn on funds in interest-bearing accounts, such as savings accounts and certificates of deposit (CDs).
Let’s take a closer look at what APY is, how it works and how it differs from an interest rate and APR.
What is APY?
Annual percentage yield (APY) simply calculates how much interest you’ll earn on your money in an account each year. APY factors in compound interest, which is interest earned both on the total amount of your principal plus any interest you’ve accumulated over time.
You’ll likely see APYs on savings accounts, CDs and other bank account products, all of which you can compare to find the account with the highest potential return. Keep in mind that APY assumes the interest rate doesn’t change for an entire year and that you don’t withdraw or deposit any more money.
How APY is calculated
APY is calculated based on the principal and accounts for interest compounding, assuming a consistent compounding frequency (e.g., daily or monthly) over a year. When interest compounds, it’s added to your total savings.
Here is the formula to calculate APY:
APY = (1+r/n)n - 1
- r = interest rate
- n = number of compounding periods per year (If a bank compounds monthly, for example, there are 12 compounding periods per year. If a bank compounds daily, there are 365 compounding periods per year).
For example, say you open a CD account with a 3% interest rate, compounded monthly (12 times per year). Following the formula, you can calculate (1+.03/12)^12-1, which equals 0.0304, or a 3.04% APY.
Now, let’s say you deposited $1,000 into that CD account with a 3.04% APY and monthly compounding. With no additional deposits or withdrawals, you can calculate your earnings using the following compound interest formula:
A = P(1+r/n)nt
- A = the future value of the account, including interest
- P = the principal deposit
- r = the annual percentage yield (or APY) expressed in decimal form
- n = the number of times that interest is compounded per unit
- t = the time the money is invested, in years
1,000 (1+0.0304/12)^(12*1) shows that your initial deposit of $1,000 becomes $1030.34 after 1 year.
APY vs. interest rate
It’s important to understand the difference between APYs and interest rates. While the APY tells you how much you can earn annually when your interest compounds, the interest rate does not reflect compounding. When you begin comparing rates, you may see these terms frequently.
APY vs. APR
An APY is how much interest you earn yearly on money saved or invested, while an annual percentage rate (APR) is how much you pay each year on money you’ve borrowed. An APR includes interest and fees. You’ll typically see APRs on mortgages, personal loans and lines of credit.
What is the difference between APR and interest rate?
An interest rate does not include fees, while APR does. Because APR accounts for costs like mortgage points, mortgage insurance and origination fees, it can better indicate how much you’ll pay yearly.
Is the APY different for savings accounts and CDs?
Savings accounts and CDs both let you earn interest on your deposits. However, savings accounts usually have a variable APY, meaning the interest rate could change over time.
CDs usually have a fixed APY, meaning once the CD account is opened, the rate does not change for a set period, called the CD term. CD accounts require you to keep your funds in the account for the term of the CD, or a penalty for early withdrawal may apply.
Using APY to compare accounts and save
While a high APY is important, it shouldn’t be your only criterion for opening an account. Small differences in rates can add up quickly. When comparing various accounts, you’ll also want to consider factors such as fees, minimum opening deposits, minimum balance requirements, bank services and other benefits.
Additionally, understand that the APY on your account can vary based on several factors, including:
- Interest rate
- Frequency of compounding periods
- Initial deposit amount
- Additional deposits
- Withdrawals from the account
- Length of time funds have been in the account
- Fees, if any
Explore APY rates and maximize your savings with Citi
Annual percentage yield can be a powerful metric for measuring the earning potential of your money over a year. By understanding how compound interest works and the differences between APY and interest rate, you can make more informed choices about which accounts to use to build your savings.
Whether you’re looking at traditional savings accounts or exploring fixed-term options like CDs, Citi offers a variety of savings products to meet your changing needs. Explore and compare the latest APY rates on savings accounts today to see how banking with Citi can support your financial goals.
APY FAQs
What is 5% APY on $1,000?
A 5% APY on a $1,000 deposit means you would earn $50 in interest over 1 year, assuming you make no additional deposits or withdrawals. Your total balance at the end of the year would be $1,050. This calculation factors in compound interest.
What is a good APY rate?
A “good” APY rate generally outpaces the national average for savings accounts and helps your money grow faster than inflation. Rates vary widely depending on market conditions, the type of account and the financial institution you choose. Comparing offers from multiple banks can also help you find a competitive return for your specific savings goals.
Is APY calculated daily or monthly?
The compounding frequency for an APY depends on the specific bank and the type of account you open. You can always check your deposit account agreement to see the exact compounding schedule for your funds.
Disclosure: This article is for general educational purposes. It is not intended to provide financial advice. It also is not intended to completely describe any Citi product or service. You should refer to the terms and conditions financial institutions provide for various products.
