APY vs. Rate
Most online banks advertise the Annual Percentage Yield of their accounts instead
of the interest rate. While both numbers represent how much your money will grow,
there is a difference between the two.
Annual Percentage Yield (APY)
The APY of an account represents
how much your account will change after a year of compounding interest. Depending
how frequently the account's interest is applied to the balance, the APY and
the rate could be the same (if interest is compounded annually) or could be slightly
different. Online savings accounts typically pay interest every month, meaning the
APY and interest rate will be different. The APY will be higher is this case and
appear more attractive to consumers. The problem with advertising APY is that interest
calculations are based on rates, not the APY.
r = interest rate, n = number of times compounded per year
The interest rate of an account is the actual number
used to calculate how much money the principal amount in the account will earn over
time. The interest rate alone cannot be used to judge an account as the frequency
in which the interest is paid also determines how much your account will earn. A
slightly higher rate that compounds only semiannually may actually provide a lower
APY than an account that offers a lower rate but compounds more frequently. Because
most people constantly deposit or withdraw funds from their accounts, the interest
rate and compound frequency are more important than the account's APY.
Calculators for determining an APY, a rate, or the amount of interest earned can
be found on the calculators page.
Next: Play with the calculators to see how your money can grow >>
Page last modified 7/25/2012