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What does 5.00% APY mean?

Published in Interest Rates 2 mins read

5.00% APY (Annual Percentage Yield) means that you will earn 5% on your deposit balance over a year, taking into account the effect of compounding interest.

Here's a more detailed explanation:

  • Annual Percentage Yield (APY): This is the effective annual rate of return, considering the effect of compounding interest. It tells you how much interest you'll earn on your deposit over a year.

  • Compounding: Compounding means that the interest you earn is added to your principal, and then the next interest calculation is based on this new, higher balance. The more frequently interest compounds (e.g., daily, monthly, quarterly), the more interest you will earn over the year. APY takes this compounding into account.

  • Example: If you deposit $1,000 into an account with a 5.00% APY, you will earn $50 in interest over the course of one year, resulting in a final balance of $1,050. This calculation incorporates any compounding that occurs during the year. The formula to calculate the final amount is:

    Final Amount = Principal * (1 + (Rate/Number of compounding periods))^(Number of compounding periods * Time)

    So, for annual compounding: Final Amount = $1000 * (1 + 0.05)^1 = $1050

  • Important Note: APY allows you to compare different interest rates more easily, even if they compound at different frequencies. A higher APY always means a better return, assuming all other factors are equal.

In summary, 5.00% APY represents the total interest you will earn on your deposit over a year, considering the effect of compounding. It's the effective annual rate of return and makes comparing different savings accounts easier.