One of the more basic terms that you should understand when it comes to your money and banking is APY, as it is a significant term in understanding how your money grows. In this blog, you’ll find a quick overview of this term. Read on!
In a nutshell:
APY= Annual Percentage Yield.
Annual percentage yield is the number that tells you how much you’ll earn with compound interest over the course of one year.
A higher APY is generally better when you’re looking at accounts for your savings. When you’re the one paying interest, a lower APY is usually best.
You will notice that interest is always paid out as a percentage.
Why is this you ask? It’s because it’s a percentage of your account balance.
Let’s do a quick and easy example:
Let’s pretend Susan has a savings account that offers 3% interest. She keeps $100 in this saving account. 3% of $100 is $3, which is the amount added to her balance in the form of interest. At the end of the year, Susan would have $103 in her account. (Yes, this is pretty much free money for Susan and can add up over time.)
However, interest doesn’t usually get paid out just once a year (usually the compounding frequency is monthly), which means Susan is earning interest on her collected interest. Unfortunately, Susan won’t receive 3% each month, so there is a calculation that goes along with this (sigh…math). In order to figure out how much interest she would earn each month, she would use the below calculation.
APY = (1 + r/n) n – 1
r= the stated annual interest rate
n= the number of compounding periods each year (generally if it’s monthly, this will be 12)
If compounded monthly, Susan would have earned $3.04 at the end of the year on her original $100.00 making a total of $103.04. Seems small, but that number can add up over time.
Learn more about banking basics in our Financial Education Center here!
