Have you noticed banks quoting their “APYs” and wondered what that means? APY stands for annual percentage yield. Banks are required to prominently display this rate for their deposit accounts, like savings accounts and certificates of deposit (CDs). APY gives you the most accurate idea of what your money could earn in a year.
What is APY?
APY indicates the total amount of interest you earn on a deposit account over one year, assuming you do not add or withdraw funds for the entire year. APY includes your interest rate and the frequency of compounding interest, which is the interest you earn on your principal plus the interest on your earnings. As you can see, APY takes into account several factors to give you a big-picture view of your earning potential.
How to calculate APY
If you like to figure things out yourself, there are a few ways you can calculate the APY on any account you’re considering. If you want to go old school with paper and pencil (and maybe a calculator), just apply the basic formula for APY:
You can also create a simple spreadsheet to do the calculations for you. This option gives you the ability to plug in different numbers to easily see how the variables—like whether the interest is compounded daily, quarterly, or monthly—affect the overall APY.
How to input APY into Excel:
- Start by setting up cells A1, A2, and A3.
- Then, enter the values in cells B1 and B2. This example uses an interest rate of 1.50 percent with daily compounding. You can check your bank statement or go online to find rates you’re interested in calculating.
- Finally, in cell B3, type =EFFECT(B1, B2) and hit “enter.” (That’s Excel’s automatic application of the formula above.) This will give you the APY (as a decimal) in cell B3.
Here’s how your spreadsheet should look now:
- Move that decimal to the right two places, and you end up discovering an APY of 1.51 percent for this example.
Of course, you can also do a quick online search for “APY calculator,” and find product-specific calculators like this one for CDs on Bankrate.com, or general calculators like this one to run some numbers for you.
So what does this all mean for your wallet?
Simply put, the higher the APY, the faster your balance grows. If you have two similar interest rates, the more frequently interest is compounded, the higher the APY will be. Those higher APYs can mean more savings for you.
Take a look at the difference in potential interest earned with a $25,000 deposit, and have a little fun imagining what that extra interest could buy:
So don’t be tempted to ignore what look like small percentage points—those numbers can really add up over time. When you’re looking to bolster your bottom line, it pays to compare APYs on CDs (certificates of deposit), savings accounts, and any other savings product you consider. That way you can be sure you’re getting the most accurate estimate of your potential earnings.