When shopping for savings rates, you are bound to come across the term “APY” – but what is APY and, more importantly, why does it matter? As with any financial term, it makes sense to educate yourself on this term since it can help you determine which savings products are right for you and your financial goals.
APY is short for Annual Percentage Yield. It reflects both a savings account’s dividend rate and how often your earnings on deposit are compounded. Compounding is when your dividends earn more dividends, which happens because the dividends you earn are added to your overall balance and earn more dividends going forward. How frequently an account’s dividends are compounded is up to the financial institution. Some financial institutions compound dividends every month, while others compound their dividends quarterly. The more frequent the compounding, the faster your savings balance can grow at even the same dividend rate.
This is why APY matters more than the savings account’s dividend rate alone. In fact, comparing APY rather than dividend rate is your best way to select a savings account if what is most important is how much it will grow your balance. If you look at dividend rates alone, you don’t get the complete picture of how much a savings account will help you earn.
For example, let’s say you are choosing between two five-year certificates of deposit, or CDs. One CD offers an interest rate of 2.956% and compounds quarterly. The other, offers the same interest rate but compounds daily.
If you invest $5,000 in the first five-year CD, which compounds quarterly, your ending balance at maturity will be $5,793.26. On the other hand, the second CD at the same five-years compounding daily will provide you with an ending balance of $5,796.37.
Example: Five-Year Certificate of Deposit
Even with the same interest rates, the compounding frequency makes these two CDs produce different annual percentage yields. When comparing the two, it's clear that more frequent compounding offers a savings advantage.
In other examples, a member may keep a balance of $25,000 and want to consider other deposit account options. The member wants to deposit this money into a Money Market Account or a Checking Account.
Simply put, an APY is the most accurate calculation of how much you will earn on a deposit over the course of a year – thus the term “annual” percentage yield. As you can see, the more frequent the compounding of a savings solution, the higher the APY and ending balance, even at the same dividend rate.
While APY includes compounding in its calculations, it does not account for any fees associated with the investment. These could include transaction fees at account opening.
APY is a term that applies to virtually any type of interest-bearing deposit account, and whether that APY is fixed or variable depends on the specific type of savings solution. For example, in a share savings account, the APY is variable – changing based on the greater dividend rate environment in the market. Meanwhile, a certificate of deposit locks in a fixed APY, allowing savers to rest easy knowing that their deposits will earn the locked-in rate until their certificate matures.
Of course, in addition to a savings product’s APY, you will want to consider other features, such as how often you can access your savings and whether you will be able to manage your savings account digitally. It is also important to select a financial institution that has knowledgeable representatives ready and able to provide you with guidance to match the right savings account to your goals. For personal assistance, with APCU/Center Parc accounts give us a call at (800) 849-8431 or to learn more about APCU/Center Parc savings and checking account options and rates visit apcu.com.
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