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BVC #6 – Compounding Interest, APR & APY [VIDEO]

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I received an email earlier this week from Tomas, asking what daily compounding meant, and I thought it would best be answered with a video post. The video discusses, in very basic terms, what compounding is as well as two common acronyms you see when talking interest rates: APR and APY.

I created an APR to APY (and back) Calculator a while back and it makes it easy to compute the two.

Please let me know what you think!

{ 14 comments, please add your thoughts now! }

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14 Responses to “BVC #6 – Compounding Interest, APR & APY [VIDEO]”

  1. jtberks says:

    Hello,
    I want to take this opportunity to thank you for your blog(s). I have been a subscriber for at least 2 years now, but I wanted to let you know that I do not like the video postings. I am not exactly sure why, but I think it is a personal preference of mine to see explanations in verse rather than listening. Though I usually find your explanations elementary (which I beleive is your intention), I seem to always find a pearl or two of information I can utilize when executing a strategy or explaining these items to others. I may unsubscribe because of the video posting, and wanted you to have that feedback. Keep up the good work.

    • Jim says:

      I’ve been doing video posts of topics I’ve covered in the past in verse, so chances are you’ve already read about them in text so the video won’t add a tremendous amount. I recommend just ignoring the posts labeled BVC in the future and it’ll save you some time.

      Thanks for being a subscriber!

  2. Cap says:

    That seems a bit ridiculous to unsubscribe just because of the videocast. You can always ignore any post starting with “BVC…” – especially since you’ve been a reader for almost 2 years.

  3. Rob says:

    Just wanted to say thanks for the great site and all the valuable information that you present on here each week. I enjoy watching the videocasts even if it is on something that I already have a good understanding of. Your explanations are clear and easy to understand. Keep up the excellent work!

  4. saladdin says:

    I will unsubscribe unless the following demands are met:

    1. Acknowledge Saladdin is your favorite forum poster.

    2. Add more pictures of swimsuit models.

    3. Give them my contact info.

    4. While doing your videos you must wear a mohawk wig and red lipstick.

    This message will self destruct in 10 seconds.

    saladdin

  5. Dee says:

    Silly question:

    If you have a savings account that compounds monthly, say on the 1st, but you withdraw all of your money on the 31st of the previous month, will you not get any interest for that period?

    • Jim says:

      Yes, you wouldn’t get interest for that period (it’s not a silly question).

      A lot of banks will say they compound daily and accrue monthly. In that case, you would get 30 days of interest even if you withdrew on the 30th day.

      • Chris says:

        The same thing goes for closing out an account with daily compounding. You would receive the 30 days accrued interest.

  6. Daniel says:

    I just want to say that the first comment in here is pretty absurd. The variety of offerings is part of what makes your site great. Keep up the good work Jim.

  7. Michael says:

    With all due respect (that means don’t get mad!!),

    I don’t think this could be any less clear… You missed the point really. Giving a formula does not explain, it simply calculates. Here’s (some of) what you missed.

    1) The APY calculates the rate of simple interest (APR) which would result in an equal amount of money over one year with compounding. For example: If $100 grows to $112 including compounding in 1 year (no matter the frequency of compounding, here we compare final balances.), the APY is 12%. Notice that if you had earned 12% simple interest on $100, you’d have the same $112 at the end of the year.

    2) The importance of APY is that it allows comparison from one product to the next. APRs are not comparable since they do not take into account compounding. Who knows if 5.25% APR compounded quarterly is better/worse than 5.251% APR compounded daily? But if you compare their APYs (which can be calculated using your formula…), you’d know the answer. You compute it, since I’m not giving the answer!

    3) Regulation DD,Truth in Savings, requires banks to quote the APY on savings products. It’s not just marketing.

    4) As for lending and APRs and APYs, the APY doesn’t really make sense. APR is required by law to be quoted (Truth in Lending Act), and it is again not marketing. The APR on a loan takes into account extra fees and additional points, etc. Here the “other rate” which one could talk about is the “note rate.” Moreoever, APRs on loans ARE comparable from one loan to the next. Also, interest on most loans is simple and not compounded. Payments are ordinarily first applied to interest, however, and then principal. The only way the interest would be compounded is if the interest were added to the principal. I believe a term used often in this case is called “Capitalizing” the interest, but I could be wrong about that term. But loans are harder to analyze since the amount of principal on which the interest is being calculated changes with each payment or additional borrowing. The formulas are crazy different when the principal is changing, and the the topics of borrowing and saving are best treated separately in these scenarios, except during periods where no payments or new borrowing(and hence reduction/increase in principal) are made.

    I hope I cleared it up a bit more. Perhaps doing another video might actually explain it. Otherwise, you could have just posted a formula.

    Feel free to email me if you’d like more explanations in the event mine were not clear or you still don’t actually understand it.

    I don’t mean to be harsh. it’s just that this is really rather elementary mathematics and should have been easy for you to explain.


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