What is APY?

The definition

APY answers one question: if I leave this money alone for a year, what percentage will I actually have earned?

That is not the same as the nominal interest rate, because interest gets added to your balance during the year and then earns interest itself. APY captures that. The nominal rate does not.

APY = (1 + r ÷ n)^n − 1

Why the rate and the APY differ

The whole gap is compounding. Nothing else changes.

On $10,000 that is the difference between $450 and about $460 in a year — small. On $200,000 over a decade it stops being small. Try it in the APY calculator.

Why banks are required to quote it

Before the Truth in Savings Act, banks could advertise returns using whatever convention flattered them: a simple rate here, a compounded one there, an "effective yield" calculated on an assumption they chose. Comparison was near-impossible.

Regulation DD standardized it. Every deposit account is quoted on the same APY basis, calculated the same way, disclosed in the same place. It is one of the more successful pieces of consumer financial disclosure precisely because it reduced a comparison to a single number.

Variable versus fixed

Almost every savings and money market APY is variable. The bank sets it, and it can change it at any time without your agreement — usually following the Federal Reserve. A high APY today is not a commitment for next year.

A certificate of deposit fixes the APY for a stated term. In exchange you agree to leave the money alone; withdrawing early normally costs you a penalty, typically some months of interest. The trade is rate certainty for liquidity.

Which is better depends on what the money is for. An emergency fund needs to be reachable, so a variable-rate savings account usually fits better than a CD, even at a lower APY.

What to check besides the number

A high advertised APY often comes with conditions. Read for:

• Tiered rates. The headline may apply only above a balance threshold, or only below one — some accounts pay the top rate on the first $5,000 and much less above it.
• Introductory rates. A promotional APY that drops after a few months.
• Activity requirements. Some accounts require a number of debit transactions or a direct deposit each cycle to earn the advertised rate.
• Minimum balance. And what happens if you dip below it.
• Fees. A monthly maintenance fee can wipe out the yield difference entirely on a modest balance.
• FDIC insurance. Confirm the institution is insured — see FDIC insurance.

Tax

Interest earned in a standard savings account is generally taxable as ordinary income in the year it is credited, and your bank will report it to the IRS if it exceeds the reporting threshold. Our calculators do not deduct tax, so the figures they produce are pre-tax. Your after-tax return will be lower, by an amount that depends on your marginal rate.