More readers requests – This is a good one though because I’ve wondered this one myself at one time…
Hello there Hank – I’m trying to find out a good place to stash my Emergency Fund to get the best interest rate, but all the sites have both APY and APR listed. What is the difference? Jeff from the UK –
Hello there Jeff – Good call to shop around for an E-Fund hiding place! There’s not a huge difference in the 2, but it IS enough to look at – APR (annual percentage rate) lets you know the annual interest rate paid on your money; but it neglects HOW it is applied. APY on the other hand, looks at how the interest is applied and applies it THROUGH the loan life. Some banks calculate this daily, some do it yearly – the more often they apply it, the better it is for you.
So for example, say you’ve deposited $10,000 into an account that has an APR of 4%. Using the APR method of calculation, you’re going to have $10,400 at the end of the year. The calculation is easy and looks like this:
APR = Periodic Rate X Number of Periods in a Year
When we use the APY to calculate the amount, we’ll say monthly, that 4% over the year will break down to .34% per month (4 divided by 12) – Your investment is now worth $10,034 after the first month. In the second month, they’ll do the same calculation, but this time it is taking that .34% of $10,034 instead of just the $10,000. So after month 2, your investment is worth 10.068.12. Yes it is only $0.12 more, but that adds up over the year. The actual APY calculation this way looks like this:
APY = (1+Periodic rate)^ # of periods – 1
In this example, even though the APR is 4%, if interest is compounded once a month, you would actually see almost $411 of earned interest after one year. That means the APY turns out to be around 4.11%, which is the actual amount of interest you’ll earn if you hold the investment for one year.
The short answer is that APR assumes that you’re not reinvesting the profits and APY does. So when shopping for a new account be that a new savings account, CD, or money market, make sure that you are comparing apples to apples. Apples (APY) to oranges (APR) isn’t going to give you a true amount that you’ll make at the end of a year. Compare the same and you’ll be able to punch them against each other with 100% accuracy. Check out the latest ones here.
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