Jason Noble was recently featured by Fortune in the article titled, “If you’re looking at savings accounts, APY is crucial for understanding your actual rate of return”

 

APY versus APR

When you are considering financial products, look carefully and run the numbers before you sign anything so you understand the big picture and how the product might ultimately benefit (or cost) you. For instance, APY, or Annual Percentage Return, is a different calculation than APR, or Annual Percentage Rate.

“APY is the annual percentage yield and outlines the real rate of return earned, which takes into account the compounding interest,” says Jason Noble, financial advisor and partner at Prime Capital Investment Advisors.

 

What is APY?

Annual percentage yield (APY) is the interest earned (or charged) on an account balance within a year and is expressed as a percentage.

This compounding factor is what sets APY apart from simple interest.

“Compounding interest is the interest you earn on the original investment and its initial interest,” says Noble. “For instance, if you have $100 that earns 1.5% interest each year, you will have $101.50 at the end of the first year. At the end of the second year, you would have $103.02. So you earned 1.5% on the entire $101.50, not just the original $100.”

 

Compound Interest: Savings Products versus Loans

The reason that knowing the APY on a financial product is important is that compound interest can boost your savings, but compound interest can add to your debt if you’re borrowing.

Savings products are generally marketed by banks using APY while loan products are marketed using APR because APY takes into account compounding interest, whereas APR doesn’t.

“Many banks will advertise their savings accounts with APYs, and in very small font show their APRs, to show the larger of the two numbers,” says Jason Noble, “while many lenders will do the exact opposite and show the APR in big letters, while keeping the APYs a lot smaller.”

“To avoid this gimmick, run both in a calculator, and it will show you the true numbers so you can make an informed decision. If you are taking out a loan, make sure to look into the APY, as that will prove to be a more reliable number for what you will pay over time,” says Noble.

 

Variable Rates

In some cases, the APY on an account can fluctuate over time. The APY can increase or decrease at any time, usually correlated with interest rate changes made by the Federal Reserve.

The APY Formula

There is a specific formula to calculate Annual Percentage Yield. The APY formula is:

APY = (1 + r/n)n – 1

The r in the equation refers to the rate, or interest rate. The n in the equation refers to the number of compounding periods within a year.

So, if you wanted to put $3,000—with no additional deposits—into a high-yield savings account earning 2% and compounds monthly (12 periods within a year), the APY formula would look like this.

(1 + .02/12)12 -1 = 0.020184

To make it a percentage, multiply that number by 100 and you get 2.0184% APY.

With an initial deposit of $3,000 you can multiply that amount by the APY ($3,000 x 2.0184%) and see how much your money would grow to within the year. Given the APY calculation, you’d have $3,060.55 at the end of the year, so you’d earn a little over $60 in interest.

The good news is you don’t have to calculate the APY on your own—banks must clearly display it for consumers to see.

“The Trust in Savings Act of 1991 mandated both APR and APY be disclosed in ads and agreements,” explains Jason Noble.

 

The Compounding Schedule

From examining the APY formula we can understand how a bank makes or pays out money in the form of interest.

Aside from understanding whether the APY is fixed or variable, you’ll want to understand the compounding schedule. For example, some accounts may compound daily, monthly, or annually.

You can earn more interest if your savings accounts compound at a higher frequency, such as daily or monthly.

And if you take out a loan that compounds frequently, you’ll pay more interest.

 

To discuss your any aspect of your financial plan, including your cash or emergency fund, call Jason Noble at (843) 743-2926.

Don’t miss Clear Picture Financial, Jason Noble’s radio show and podcast each Sunday, where you will learn how you can protect your portfolio and stay on course with your long-term financial and retirement plans. Jason and his team help retirees, those who want to retire early, and business owners who are looking for a work-optional lifestyle.

 

 

Read the entire article on Fortune here.