Question

Why should a person use APY instead of interest rate when comparing savings accounts?

Answer 1

APY stands for Annual percentage Yield, It tells what the holder of the savings account is actually earning in his account.

APY depicts the effects of compounding , it also determines how much we interest we earn on the savings per year, along with the effects of compounding. APY takes into account both the interest rate and compounding period, so it better depicts how much we will earn.

if interest is to be paid on an annual basis, then the interest rate and the APY both mean the same. But when compounding is done, as annual, monthly, quarterly in such case compounding effect occurs. Compounding cycles is the number of times a year your interest compounds.

In case of compounding the APY can be calculated as:

if its 4% rate compounded daily, then the APY IS :

100 * [ (1 +( 0.04/365)^365) - 1]

= 4.08%

Interest rates are a stated interest rate for the savings account. APY will always exceed the savings account interest rates even if it is marginally. This looks as a better investment for the customer hence the banks always advertise the APY , which shows that there is a higher potential for the money to grow, due to the compounding.