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What Is Annual Percentage Yield (APY)?
The annual percentage yield (APY) on a certificate of deposit (CD) is the interest you earn over a year, expressed as a percentage. APY includes the raw interest rate you're paid for your CD and the effect of compounding. APY is the standard measurement of a CD's returns. If you're looking for the best CDs paying the highest rates, you should look at the APY each offers. Learn more about APY and how to use it to find the best CD for you.
Key Takeaways
- The annual percentage yield (APY) of a certificate of deposit (CD) is the interest a CD pays in a year.
- APY is a useful measure of CD returns because it includes compound interest.
- When comparing CDs, look for the highest APY for your desired investment term length.
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Investopedia / Zoe Hansen
Understanding Annual Percentage Yield (APY)
The annual percentage yield (APY) is the real rate of return earned on an investment, considering compounding interest. CDs pay compounding interest, as do standard savings accounts and money market accounts. An APY helps consumers avoid complicated calculations and compare different account options.
CDs typically pay compound interest monthly or even daily. Unlike simple interest, compounding interest is calculated periodically and immediately added to the balance. As the account balance increases with each period, the interest paid on the balance also increases.
A certificate of deposit (CD) rate of return is generally quoted as the APY.
Compounding only occurs if the owner doesn't withdraw the interest in the CD. Some CDs allow you to transfer dividends to another account, but if this option is chosen, the benefits of compounding are lost. The full APY on the CD has not been received.
The APY quoted for a CD already considers the effect of compounding, whether monthly or daily. So, if you see a CD that compounds monthly and has an advertised APY of 1%, the CD provider has already carefully calculated the actual amount of interest paid per month.
This makes comparing CDs much easier because customers don’t have to calculate annual yields. It also allows the bank to quote a more impressive percentage return (1% APY rather than 0.08% monthly).
However, it can be a little confusing when you get an account statement for your CD and see that the interest rate you are receiving is less than the advertised rate. If you run through the math, you’ll probably see that the difference is due to compounding. If it’s not, you should contact your CD provider.
Note
CD APYs closely move with the federal funds rate. If rates decline, APYs on CDs go down. If rates move higher, APYs will increase.
Finding the Best APY on a CD
The top nationally available CD APY rates are typically three to five times higher than the industry average for every term, so shopping around can deliver significant gains.
Generally, a bank or credit union will pay you a higher APY for CDs requiring a higher initial deposit. By law, the bank or credit union must let you know if a minimum balance is required to earn an advertised APY.
Institutions have traditionally paid more for CDs with longer terms. However, short-term CDs have recently offered high rates, too.
The APY will tell you all you need to know about the returns you’ll receive from a CD and how it compares to other CDs on the market.
APY and Penalties
The only extra factor you’ll normally have to consider is the CD early withdrawal penalties and bank charges. The penalty amounts vary between CD accounts but tend to be several months' worth of interest.
With a CD, you should expect to leave your money in the CD for the entire term. Still, if you suspect you might need the money in an emergency, you should ensure you understand the penalties for accessing it early.
Frequently Asked Questions (FAQs)
How Much Does a $10,000 CD Make in a Year?
The amount any CD makes in a year depends on the APY. For example, a $10,000 deposit in a five-year CD with 1.50% APY would earn around $770 in interest, while the same deposit in a five-year CD with 0.01% APY would earn only $5.
What Does 5% APY Mean?
This means a CD (or another kind of account) that pays 5% in returns annually. Most bank accounts offering interest display the annual rate as an APY. If you deposit $1,000 into a high-yield savings account that calculates and pays interest monthly, you will end the year with $1,051.16.
What Is a Good APY?
The national average savings rate as of August 2024 is 0.46% APY, but you can easily find CDs with APYs higher than this. The top one-year CD, for example, pays an APY of 5.25%.
The Bottom Line
The annual percentage yield (APY) of a certificate of deposit (CD) is the interest a CD pays in a year. If a CD pays 1% APY and you deposit $100, for example, you will have $101 at the end of the first year.
APY is a useful measure of CD returns because it considers the effect of compound interest. When looking for a CD, you should look for the account with the highest APY for the length of your desired investment term. Just make sure you also understand the early withdrawal penalties associated with the CD account you choose.