What Does APY Mean?

When talking about saving opportunities like savings accounts, savings certificates, money markets, etc., credit unions and banks always throw out some percentage followed by 3 letters… APY. What do those letters mean and does it affect your money?

What Is APY?

APY stands for Annual Percentage Yield and is usually tied to some type of savings account. Expressed as a percentage, APY tells you what you will earn on your deposits over the course of a year. So, every time you deposit money into a traditional savings account, high-yield savings account, money market account, or savings certificate, it grows at the APY interest rate, giving your money dividends. Dividends are the money accrued via the compounding APY interest rate. APY is calculated as:

APY = (1 + r/n)n – 1

Compound Interest

Interest is what allows your money to grow in your account. Think of it as a small thank you from the financial institution for keeping your money with them. A regular interest rate grows the initial deposit in your account at the same percent rate over time. Using APY, your initial deposit compounds the interest for a year. Compounding interest allows for the earned dividends to also grow along with your initial deposit.

Show Me The Numbers

Let’s say you deposited $500 into a savings account at 5% interest that compounds monthly. Once you deposit the money and let it sit for a month, it will earn one month’s of interest at 5%. Your money will have grown to $502.08, or 500 x (1 + .05/12). Compounding interest hasn’t taken effect yet. This is just your money growing at the regular interest rate.

In the second month, the total amount in the account will grow at 5%, including the extra $2.08 you earned in dividends from last month, amounting to a total of $504.17 or 502.08 x (1 + .05/12). Your money will continue to grow month after month as long as the investment principal (or the initial amount you deposited), stays the same or the APY doesn’t decrease.

What Does It Mean For You?

When choosing your next savings solution, try to find one with the best APY. The higher the APY interest rate, the more you will earn on your deposits! Which one is for you?

  • Traditional savings accounts will have lower APY interest rates with more flexibility and access to your money.
  • Money market accounts will have high APY interest rates but require large minimum deposits.
  • High-yield savings accounts are like the name. They act like traditional savings accounts with flexibility and easy access with the perks of a high interest rate like a money market account. This is a newer account type with varying requirements.
  • Savings certificates offer a guaranteed high interest rate over a specific amount of time. The money is locked in no matter what happens over the term.

Each savings account type is designed to fit different lifestyles and reach different financial goals. Whichever you pick, make sure it has a good APY interest rate so you can sit back and watch your money grow.