When it comes to my savings, I care about one thing – getting the highest and best APY possible for my money. You can spend millions of dollars on advertising, you can hire the best PR and marketing people in the world, and you can make the couches in your branches fluffy and the smiles genuine but the bottom line is the bottom line. There’s a reason why people look at a bank’s rate tables first, it all comes down to the money. For savers, especially in this extremely tough saving environment, it’s about maximizing annual percentage yield.
What is APY? APY stands for Annual Percentage Yield and it’s a normalized interest rate that you can use to compare different financial accounts. It takes into consideration the compounding period, the interest rate, and the duration of the deposit. Some accounts compound monthly, others compound daily, and even others compound “continuously,” and so an APY will take an APR, annual percentage rate, and normalize it so you can compare accounts’ interest rates on an even level. Most importantly, how you calculate it is governed by FDIC law  so you know the number is legitimate.
The FDIC Truth in Savings Act of 1991  has an official definition for APY – “The term “annual percentage yield” means the total amount of interest that would be received on a $100 deposit, based on the annual rate of simple interest and the frequency of compounding for a 365-day period, expressed as a percentage calculated by a method which shall be prescribed by the Board in regulations.”
APY vs. APR
What is APR? You’ll usually see interest rates on debt, such as a mortgage or credit card, expressed in APR terms because the number is smaller. Interest rates on deposits, like savings accounts and CDs, will usually be written as an APY because the number is larger. With interest rates so low, there isn’t a large nominal difference between APR and APY. As the numbers get larger, the difference becomes larger. For example, an APR of 10% expressed as a daily compounded APY is 10.52%. An APR of 1% compounded daily is only 1.005% – which is a minute difference. Here’s an APY to APR (and back) calculator  I created to help calculate this.
This is important because the two numbers explain different things, despite being separated by only one letter in the acronym.
You may have heard the term “yield curve” if you turned on CNBC or Bloomberg. Yield curves usually refer to the yields on Treasury notes and it’s the benchmark against which other deposit accounts are compared. Usually the longer the maturity, the higher the rate. So a 10 Year Treasury note will have a higher yield than a 3 Year Treasury note. Take a look at the daily Treasury Yield curves  and you’ll see what I mean. There are some scenarios where the curve “inverts,” meaning a longer maturity offers a lower rate than a shorter one, and those are typically very specific economic scenarios. When it comes to regular banks, the yield curves refer to CDs, which are like Treasury notes in that the principal is secure (more secure than a corporate bond). Again, the yield curve will almost always remain the same or increase as maturity increases.
This is important because you want to check out a bank’s full yield curve when looking for the best APY. If you plan on making a CD ladder, you’ll want a bank with higher rates on their longer maturities, even if that means sacrificing a little on the short end of the curve.
Finally, I wanted to address something that savers used to do when rates were less uniform. Several years ago, when many banks were offering online savings accounts  for the first time, they would compete with their rates. The newer banks were all FDIC insured, 100% legitimate, and offered similar products – but they juiced up their APY to try to entice more customers. While this is happening less often today, you might be tempted to switch banks for an extra 0.1%. Unfortunately, in most cases, switching for that little of an amount is typically not worth it for two reasons:
- Moving money takes time – When you transfer money from one bank to another, it’ll take about a week. That’s a week where your money isn’t earning interest and the time lost will not be recovered by a small interest rate increase.
- The bit of taxes – Remember that bank interest is taxed as ordinary income, so it’s the same tax brackets  as your job. Calculate the time and effort needed to open an account, move the funds, and then account for another tax form during tax season next year. Is it still worth it?
Sadly, at the end of the day, the best APY banks aren’t separated by much when it comes to interest rates. Until we fully recover from the Great Recession and the Federal Reserve pulls the target rate above zero, the definition of “best APY” won’t carry much meaning.
(Photo: franganillo )