APY Includes Compounding, but It Does Not Describe Every Account Cost

Annual percentage yield, or APY, expresses deposit interest on an annualized basis under defined assumptions, including compounding. It helps compare interest offers, but it is not a complete description of an account's cost or suitability.

Rate and yield are related, not identical

An interest rate describes the rate used to calculate interest. APY incorporates the effect of compounding over the relevant annualized period. When interest is added to the balance and can itself earn interest, the resulting yield can differ from the stated rate.

This explanation concerns deposit accounts, not the annual percentage rate used in many borrowing disclosures. Similar abbreviations should not be compared as though they describe the same financial product.

Read the assumptions beside the number

Check whether the advertised APY requires a particular balance, applies only to a tier, or is promotional. Determine whether the rate is variable or fixed for a stated term. A displayed annualized figure does not promise that a variable rate will remain unchanged for a year.

Account fees and other conditions can affect the outcome. A monthly charge can matter more than a small yield difference for a modest balance. Access restrictions and early-withdrawal terms may also be relevant, depending on the product.

Compare a realistic use case

Write down the balance you expect to hold and the period you expect to keep it there. Compare the actual disclosures for those conditions. Do not rank accounts using a headline rate that applies to a different balance or an offer you cannot meet.

APY is a useful standardized measure within a larger comparison. It does not establish deposit protection, predict future rates, or replace reading the account agreement. This article explains the terminology; it is not a recommendation to open a particular account.