If you're focused on saving money for the short or long term, APY, or annual percentage yield, is an acronym worth knowing and understanding because it gives you a good idea of what your money can earn in a year.
What does APY mean?
Your APY simply shows the amount of interest you earn on your money in a bank account over one year and includes compound interest. APY assumes the interest rate doesn't change for an entire year and no additional deposits, fees, or withdrawals occur with your account. Compound interest is the interest you earn both on the total amount of your principal plus any interest you've accumulated over time. Interest typically can compound daily, monthly or annually, then it's added to your total savings.
The higher the APY, the better for your savings efforts. It definitely benefits you to pay attention to your bank's savings account APY. A high APY savings account can help you save for goals like a new car, trip, or down payment on a home.
How APY is calculated
The formula for APY may look more complicated than it actually is.
APY = (1+r/n)n - 1
In this case:
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.)
r = 0.0202 (2.02% interest rate)*
n = 12 (12 compounding periods per year)
APY is 2.04%* = (1+(0.0202/12))12 - 1
Now that we know the APY is 2.04%*, we can bring this to life. If you invested $5,000 with that APY of 2.04%* and monthly compounding (with no additional deposits/withdrawals), you would have $5,101.94 in a year. If you'd like to calculate the interest yourself, here's the formula you would use:
A = P(1+r/n)nt
A = the future value of the investment, including interest
P = the principal investment amount (the initial deposit)
r = the annual interest rate (in decimal form)
n = the number of times that interest is compounded per unit
t = the time the money is invested
This formula shows how the initial deposit of $5,000 becomes $5,101.94:
APY is 2.04%* = $5,000 (1+0.0202/12)(12*1) = $5,101.94
APY vs. Interest Rate
It's important to understand the difference between APY and interest rate. While an APY includes compound interest in its calculation, in the context of savings the interest rate is simply the annual rate of interest paid on savings. It does not factor in compound interest. When you begin to compare rates, you may see these terms regularly.
While the APY tells you how much you can earn when your interest compounds, the interest rate does not work the same way.
Is APY different for savings accounts and CDs?
Savings accounts and CDs both offer the ability to earn interest on your savings and will both have an APY.
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 interest rate does not change and remains fixed for a certain length of time, called the CD term. In exchange for the fixed rate, CDs require you to keep your funds in the CD account for the term of the CD or face a penalty for early withdrawal. Citi also offers No Penalty CDs with a fixed APY. These CDs offer more flexibility and access to your savings by allowing you to withdraw your full balance without penalty, beginning seven days after the no-penalty CD is funded.
APY and saving money
APY is your friend when it comes to saving for the future. Small differences in rates can add up quickly, so even a few hundredths of a percentage point can be meaningful in the long run. You can use APY to better understand how one savings account may help you reach your financial goals versus another.
While a high savings APY is important, it shouldn't be your only criteria for opening an account. You will also want to be on the lookout for fees or minimum opening deposits, minimum balance requirements, ease of access to savings and fund transfers, bank services and other product benefits, features and offers.
Take the time to examine various savings accounts and CD accounts to ensure you select the best APY savings account for your needs. The APY and amount you can make on your savings will vary based on several factors, including:
- Interest rate of the account
- The frequency of compounding periods
- The amount of your initial deposit
- Any additional deposits you might make
- Any withdrawals on the account
- How long you've had funds inside the account
- Fees, if there are any
If you can add to your savings accounts - even a small amount each week or month – as well as refrain from withdrawing funds, then your APY will be even more powerful when it comes to growing your savings.
As you can see, when you understand APY and the power of compound interest, you can better plan how to grow your savings. Then you can let your savings carry you faster towards your financial goals.
Citi offers competitive savings rates and a variety of account options. You can check out and compare the latest APY rates for various accounts online.
*Rate provided is for illustrative purposes only.