Annual percentage yield (APY)

Before you rely on it

What to check

Check whether the advertised yield is promotional, and whether it applies above a certain balance or only below one.

The common error

Where people go wrong with annual percentage yield (APY)

Chasing a headline APY that expires in three months, on a balance cap of a few thousand dollars. The blended yield over a year lands nowhere near the number on the ad.

Worked through

Annual percentage yield (APY) in plain numbers

Two banks each advertise 5.00%. Bank A pays 5% interest compounded monthly. Bank B compounds daily. The monthly version grows $10,000 to $10,511.62 in a year, so its APY is 5.116%. Daily compounding reaches $10,512.67, an APY of 5.127%, and the gap is $1.05 on ten thousand dollars. Small, but real, and it grows with the balance and the number of years; a third account quotes 5.10% compounded annually and grows to $10,510.00, which ranks below both once you convert to APY. Only after conversion can you sort them fairly.

Easily confused

Annual percentage yield (APY) and its neighbours

APY and APR sound alike and point in opposite directions. APY describes what a deposit earns, after compounding within the year. APR describes what a loan costs, before compounding; both are annual, but a bank wants a high APY and a borrower wants a low APR. APY also differs from the stated rate, sometimes called the nominal rate, which ignores how often interest is added; the rule of thumb is short. Compare deposits by APY, compare loans by APR, and never compare one against the other.

In real decisions

Where annual percentage yield (APY) turns up

APY is the number to use when choosing a savings account, certificate of deposit or money market account; it converts different compounding schedules into one figure you can rank. Savers also use it to project balances: a $20,000 balance at 4.5% APY grows to about $20,900 in a year, whatever the compounding schedule beneath it. Advertising rules in many places require banks to quote it, so it turns up in every rate table; it is also the right input for comparing a bank deposit with a bond's yield.

Know the edges

Where annual percentage yield (APY) stops being reliable

APY assumes the rate stays put for the whole year, and most savings rates do not. Promotional rates can expire after a few months; some accounts pay the top rate only on balances up to a cap, or only if you meet monthly activity rules. Fees can eat the interest on small balances. Taxes reduce it further. The number on the ad is a ceiling for a well-behaved account, so read the terms for the blended yield you would really get.

Quick answers

What people ask about annual percentage yield (APY)

Is a higher APY always the better account? Only if the terms match. Check the minimum balance, any cap on the rate and whether the rate lasts. A promotional 5% on the first $2,000 can earn less than a steady 4.3% on the whole balance. Compare what you would actually earn on your own balance.

Does APY include fees? No. APY reflects interest and compounding only. A monthly fee can wipe out the interest on a small balance, so subtract fees yourself before comparing accounts.