What Is APY? The Complete Guide to Annual Percentage Yield
Understanding APY is the first step to making your money work harder. Here's everything you need to know.
📌 Key Takeaways
- APY (Annual Percentage Yield) is the total interest you earn on deposits over one year, including compound interest.
- APY is always higher than APR because it accounts for compounding—interest earning interest.
- Daily compounding earns slightly more than monthly compounding at the same rate.
- Top high-yield savings accounts currently offer 4-5% APY vs. traditional banks at 0.01%.
When comparing savings accounts, you'll see "APY" everywhere. Banks use it to advertise their rates, and comparison sites use it to rank accounts. But what does APY actually mean, and why does it matter for your savings?
APY Definition: What Does APY Stand For?
APY stands for Annual Percentage Yield. It represents the total amount of interest you'll earn on a deposit over one year, expressed as a percentage. Crucially, APY includes the effect of compound interest—interest earned on your interest.
For example, if you deposit $10,000 in a savings account with a 4.00% APY and leave it untouched for a year, you'll have $10,400 at the end (assuming the rate doesn't change).
APY vs APR: What's the Difference?
APY and APR are related but not identical:
APY (Annual Percentage Yield)
- • Includes compound interest
- • Used for savings/deposits
- • Tells you what you'll earn
- • Always ≥ the interest rate
APR (Annual Percentage Rate)
- • Simple interest only
- • Used for loans/credit cards
- • Tells you what you'll pay
- • May exclude some fees
When you're saving money, you want to see APY (higher is better). When you're borrowing money, you'll typically see APR (lower is better).
Why the difference matters: A loan at 4.00% APR actually costs you more than 4% per year once compounding kicks in. Conversely, a savings account at 4.00% APY is already accounting for compounding—that's exactly what you'll earn.
How Compound Interest Works
Compound interest is the secret sauce that makes APY powerful. Instead of just earning interest on your original deposit, you earn interest on your accumulated interest too.
Here's a simple example with $10,000 at 4% interest:
Simple Interest vs. Compound Interest (4% rate)
| Year | Simple Interest | Compound (Annual) | Compound (Daily) |
|---|---|---|---|
| Start | $10,000.00 | $10,000.00 | $10,000.00 |
| Year 1 | $10,400.00 | $10,400.00 | $10,408.08 |
| Year 5 | $12,000.00 | $12,166.53 | $12,213.89 |
| Year 10 | $14,000.00 | $14,802.44 | $14,918.16 |
| Year 20 | $18,000.00 | $21,911.23 | $22,254.43 |
Daily compounding assumes 365 days/year. Demonstrates power of compound frequency over time.
Notice how the gap widens over time. After 20 years, daily compounding earns you over $4,000 more than simple interest on the same deposit at the same rate. That's the power of compound interest.
Daily vs Monthly Compounding: Does It Matter?
Most high-yield savings accounts compound interest daily, while some compound monthly. In practice, the difference is small but real.
At 4% interest on $10,000:
- Annual compounding: $400.00 interest earned
- Monthly compounding: $407.42 interest earned
- Daily compounding: $408.08 interest earned
Daily compounding earns about $0.66 more per year than monthly compounding on $10,000. Not life-changing, but it's free money—why leave it on the table?
Pro tip: Most top high-yield savings accounts (Ally, Marcus, SoFi, etc.) compound daily. You don't usually need to check, but it's worth confirming if you're comparing two otherwise-identical accounts.
How to Calculate APY
If you know the interest rate and compounding frequency, you can calculate APY with this formula:
APY = (1 + r/n)ⁿ - 1
Where r = interest rate (decimal) and n = compounding periods per year
For example, with a 4% rate compounding daily:
APY = (1 + 0.04/365)³⁶⁵ - 1 = 4.0808%
That's why a bank might advertise "4.00% rate" but "4.08% APY"—they're both accurate, but APY is the more meaningful number for comparing accounts.
What's a Good APY in 2026?
APY benchmarks change based on Federal Reserve interest rate policy. As of January 2026:
These benchmarks will shift as the Fed adjusts rates. When rates were near zero (2020-2021), even 0.50% APY was considered good. The key is to stay above the national average savings rate, which currently sits around 0.41%.
Why Online Banks Pay Higher APY
You might wonder: why do online banks pay 3-5% APY while Chase pays 0.01%? It comes down to cost structure.
Traditional banks spend billions on:
- Real estate for branches
- Salaries for tellers, managers, and security
- Utilities, maintenance, and insurance
- ATM networks and physical infrastructure
Online banks like Ally or Marcus don't have these costs. They operate with small teams, modest office space, and digital-first infrastructure. The savings get passed to customers as higher APYs.
Both types of banks are FDIC-insured and equally safe. The difference is purely operational efficiency.
The Real-World Impact of APY
Let's put APY differences in perspective. Here's what various APYs earn on a $25,000 emergency fund over one year:
The difference between Chase and a high-yield account is over $1,100 per year on a $25,000 balance. Over a decade, that's $11,000+ in lost earnings—just from keeping money in the wrong account.
Common APY Mistakes to Avoid
1. Confusing APY with Interest Rate
Some banks advertise their "interest rate" instead of APY to make their offering seem competitive. Always compare APY to APY for an apples-to-apples comparison.
2. Ignoring Promotional vs. Ongoing APY
Some accounts offer a high introductory APY that drops after 3-6 months. Make sure you know the long-term rate, not just the teaser.
3. Chasing Tiny APY Differences
A 0.10% APY difference on $10,000 is $10/year. If achieving that extra yield requires jumping through hoops (direct deposit requirements, minimum balances, etc.), it may not be worth the hassle.
4. Forgetting APY Can Change
High-yield savings account rates are variable. When the Fed cuts rates, APYs typically follow. Don't assume today's rate is permanent.
Frequently Asked Questions
Is APY guaranteed?
No. High-yield savings account APYs are variable and can change at any time based on market conditions. CDs offer fixed APYs for their term length.
Do I pay taxes on APY earnings?
Yes. Interest earned on savings accounts is taxable as ordinary income. Banks send you a 1099-INT form if you earn more than $10 in interest per year.
What's the highest APY available?
As of January 2026, the highest widely-available APY is around 5.00% from Varo (on the first $5,000 with direct deposit). The highest no-strings APY is around 4.60% from Pibank.
Does higher APY mean higher risk?
Not for FDIC-insured accounts. Whether a bank pays 0.01% or 5.00% APY, your deposits are equally protected up to $250,000. The difference is the bank's business model, not risk level.
Ready to earn more on your savings?
Compare high-yield savings accounts with APYs from 3.50% to 5.00%.
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