What is APY? How does it work?
Some deposit accounts, like savings accounts, earn interest. That means the bank will periodically credit a certain amount to the balance of the account, based on a percentage set by the bank. The bank also sets how often the interest compounds, or accrues to the balance. Compound interest means earning interest on interest that has already accrued to the account.
The total amount the bank pays in interest, including compound interest, each year is called the annual percentage yield (APY).
That means that when you agree to a bank’s terms and conditions for opening a new deposit account, the agreement will sometimes list both an interest rate and an APY. The interest rate may be a lower number than the APY, because the APY also takes into account the interest already earned during each compounding period.
Many types of deposit accounts earn interest. You may see an APY listed for savings accounts, money market accounts, and some checking accounts. The APY is an important figure to know if you’re planning for your financial future, because it can give you some idea of what you’ll save in a year.
This year, to help clients build long-term wealth, M1 is launching a new savings account furnished by B2 Bank that will earn 4.50%* APY for M1 Plus members. (Nationally, the average interest rate for checking and savings accounts is about 0.37%.)
Read on to learn more about how APY may help you save.
How does compound interest work?
Interest is the amount the account earns during the year, computed on a timeline according to the bank’s rules. Periodically, the computed interest will accrue to the account balance to increase it, which is called compound interest.
Compounding occurs during a specific compounding period. For example, say your bank compounds interest monthly. In that case, if you had $10,000 in an account and it earned $100 in interest in one month, by the next month you’ll be earning interest on the full $10,100 balance, assuming you don’t withdraw any of the money in the account.
The account’s APY typically considers both the interest rate and how often interest is calculated and compounded. The more often interest is compounded, the higher the APY could potentially be, since the balance on the account would be growing faster.
APY vs APR
APR stands for annual percentage rate. It’s the way banks and other lenders calculate how much interest you’ll owe on the principal balance of a loan or other forms of debt.
Other than a similarity in the name, APY and APR have little in common. An APY can help you figure out how much you’ll earn on a deposit account, like a savings account. An APR tells you how much you’ll have to pay on a debt balance.
APY vs ROI
A return on investment (ROI) is what you receive when an asset increases in value. If you owned a stock worth $100 per share, and it goes up to $105 per share, then you’ve received a 5% ROI. By that same token, if the stock goes down to $95 per share, then you’ve received a -5% ROI.
The ROI figure appears similar to APY because both describe potential gains (although it’s possible to have a negative ROI). But an important difference between APY and ROI is that yields happen automatically while a return on investment only happens when a security changes value. Additionally, the APY calculation can only apply to money in an interest-bearing deposit account.
In other words, securities like stocks and ETFs don’t really earn an APY. Any gains you may receive on those types of financial products are your returns. But if you had cash in a savings account that earned interest, you might calculate those earnings using APY.
Where to get the best APY
According to federal data, the average national interest rate on savings accounts is a little over 0.37%. That’s actually substantially higher than it was as recently as 2021, when the average was around 0.06%. Part of the reason average interest rates are so low is because most of the biggest banks offer even less than that. It’s common to see interest rates as low as 0.01% for savings accounts at major financial institutions.
At M1, we’re soon launching a high-yield savings account furnished by B2 Bank with a 4.50%* APY, which will help supercharge your savings by allowing you to potentially earn more each year than with almost any other savings account on the market.
*Obtaining stated APY (annual percentage yield) or opening an account does not require a minimum account balance. Stated APY is valid from date of account opening. Account fees may reduce earnings. Higher APY rate subject to paid M1 Plus subscription. Rates are subject to change. Stated APY (annual percentage yield) for M1 Savings accounts is subject to change prior to product launch due to changing federal funds rate.
M1 is not a bank. M1 Spend is a wholly-owned operating subsidiary of M1 Holdings Inc. M1 Savings Accounts are furnished by B2 Bank, NA, Member FDIC.