What Is APY? Understanding Annual Percentage Yield

APY, or Annual Percentage Yield, shows your investment return. It helps compare accounts by factoring in compound interest. Understanding APY calculation is key to investing smartly.

While APY applies to basic savings accounts, it’s also important to understand its role with other savings options, such as share certificates, money manager accounts, and IRAs. Read on to learn more about APY or contact HFS FCU today.

What Does APY Mean?

APY, or Annual Percentage Yield, represents the interest earned on an investment, including interest accumulated on prior interest. It factors in the interest rate and compounding frequency, allowing direct comparison between accounts.

People may call an interest rate “really” X% when discussing yearly earnings. This figure is the APY, which includes the base rate and compound interest.

Per the 1991 Truth in Savings Act, financial institutions are required to disclose APY. Now that we’ve covered what APY is and why disclosure is important, let’s look at how APY is calculated.

How Is APY Calculated?

To understand how to calculate APY, it’s helpful to break down the formula:

• APY = (1 + r/n) – 1

Where:

• r = Annual interest rate (expressed as a decimal)
• n = The number of times interest is compounded in a year (e.g., 12 for monthly compounding or 4 for quarterly compounding).

Take, for example, a savings account with a 4% interest rate (r = 0.04) that’s compounded monthly (n = 12). The formula would be as follows:

• APY = (1 + 0.04/12) – 1

APY would equal 4.07%.

You don’t need to calculate APY by hand—many calculators do it for you. What matters is understanding the calculation.

APY vs Interest Rate: What’s the Difference?

People often confuse APY and interest rate. It’s important to know their differences:

• The interest rate is the percentage paid on your principal balance. The interest rate does not account for compound interest.
• APY combines interest rate and compounding to provide a more accurate picture of your earnings.

While both terms are useful, APY better reflects your savings’ true growth.

APY vs APR: Know the Difference

APY (Annual Percentage Yield) and APR (Annual Percentage Rate) are both measures of interest, but they serve different purposes. APY reflects the amount of interest you earn on deposits in an account over a year, including the effect of compounding. In contrast, APR shows the interest rate you pay when you borrow money with a loan or credit card, without compounding. Both rates appear on your credit card statement, but they are calculated differently:

• APR expresses the annual cost of borrowing money but only reflects the simple interest rate, not compounding or additional fees. It measures the cost of debt on loans and credit cards.
• APY considers fees, compounding, and other variables, while APR typically does not. APY provides a comprehensive measure of how much money will truly grow, accounting for all these factors.

In summary, you want a higher APY when saving to maximize earnings, and a lower APR when borrowing to minimize interest costs. Next, let’s examine how compound interest actively influences your APY.

How Compound Interest Affects Your APY

Compound interest means you earn interest on your original investment and on the interest you’ve already earned, helping your money grow. It’s a powerful, often overlooked personal finance tool.

Compound interest lets your money grow passively. If you deposit $1 in a savings account with 5% compound interest, after one year, you have $1.05. After two years, $1.10. After ten years, your investment doubles. Even with small sums, compound interest adds up over time.

Interest can be compounded daily, monthly, quarterly, or annually. More frequent compounding increases your APY.

APY in Action: A Real-World Example

If you invest $1,000 at a 5% annual rate, you’d earn $50 in a year. But with monthly compounding, the APY is 5.116%, giving you $1,051.16 after one year. Even small sums show the advantages of APY.

Now, consider a $10,000 investment. One account offers 5% compounded quarterly; another, 4% compounded monthly. Which is better?

Calculating the APY, Option 1 yields $10,509.45 after one year; Option 2, $10,407.42.

Even though the second option compounds more often, the first option’s higher rate gives better earnings. Always consider both interest rate and compounding frequency.

What Is a Good APY for a Savings Account?

APY depends on market conditions and interest rates. The current average savings APY is 0.40%; high-yield accounts are usually 4–5%.

If you’re looking for a good APY, don’t just zero in on one type of account — assess APYs across different account types. This includes savings accounts, money manager accounts, and share certificates.

Fixed vs Variable APY

Share certificates have fixed APYs for the full term. Savings and money manager accounts usually have variable APYs tied to market changes. Choose based on your goals.

For example, a fixed APY provides greater certainty by guaranteeing a constant rate. Fixed rates protect you from any sudden decreases, but you won’t be able to take advantage of any increases.

Variable APYs offer more flexibility (and potentially, volatility), giving you higher returns if rates rise and lower returns if rates fall. As you weigh your options, consider these strategies to maximize your APY.

Tips for Maximizing Your APY

It’s only natural to want to make your money work harder for you, so it makes sense to maximize your APY. Some strategies for doing this include:

• Shop around and compare APYs across different financial institutions. Be sure to look beyond rates and consider fees and accessibility as well.
• Ladder share certificates to balance competitive rates and liquidity needs.
• If possible, leave funds untouched to take full advantage of compound interest over time. Remember, compound interest is most significant with larger sums over longer periods.

At HFS FCU, we’ll help you maximize your APY by putting you in the right accounts based on your savings goals. Understanding key financial concepts is vital for making informed choices about your money.

Start Earning Competitive APY with HFS FCU

Why is it important to know concepts like APY? It’s essential to understand how different aspects of investing can affect your money. Knowing about APY and APR, and understanding compound interest means you can compare financial and investment opportunities — from standard savings accounts to money manager accounts to share certificates and IRAs — to make the most of your assets. If you’re ready to take the next step, here’s how HFS FCU can assist you with your investment journey.

Are you ready to take a serious look at real investment opportunities? HFS FCU can help. Serving the island of Hawaii since our founding in 1937, we’re dedicated to providing our members with competitive rates and focused service, ensuring their money works harder for them. For more information on HFS FCU and our savings options, contact us today.

FAQs About APY

What does APY stand for?

APY stands for “Annual Percentage Yield,” which is the total amount of interest earned on a deposit account over a year.

Is a higher APY always better?

While a higher APY tends to be better for savings, it may also come with less favorable terms (e.g., higher fees, less account flexibility, balance requirements, etc.).

How often is interest compounded on savings accounts?

Interest is usually compounded daily or monthly. Sometimes it’s quarterly or yearly. More frequent compounding grows your savings faster.

What’s the difference between APY and dividend rate?

APY includes the impact of compound interest, while the dividend rate is the base rate earned on a deposit over a year.

Can APY change after I open an account?

Yes, APY can change for some banking options after you open the account. For example, high-yield savings accounts, checking accounts, and money manager accounts typically offer variable rates that can change over time.

How much will I earn with a 4% APY on $10,000?

A $10,000 deposit with a 4% APY will earn $400 in interest in one year, assuming the rate remains fixed at 4% and no withdrawals or additional deposits are made.