Bill Gerhard: Hi! I am Bill Gerhard, Director of Financial Services for AAA. In this series of videos, we discussed how to invest in CDs, Money Markets and Savings Accounts. Now we look at comparing rates APR and APY.
Compound Interest is the money added to the principal or the original investment. Your principal, plus the interest it earns continues to earn interest throughout the period of your investment, that growth is called Compound Interest or Compounding.
You've probably seen abbreviation APY, which stands for Annual Percentage Yield. APY represents how interest accrues. For example, you may have a rate of 2.
25% with an APY of 2.
33% that means the interest has been added to the amount and is earning interest on interest.
APR stands for Annual Percentage Rate. It's the rate the institution pays you without compounding. An easy rule of thumb is just to make sure that you are comparing apples to apples. Look at competing APYs. Interest can be added to your account at any time, daily, monthly or annually.
Daily compounding is the most common, the more frequent the compounding the more you earn. So check with your saving institution to see how they compound. That's means they convert APR into APY, a rate into a yield or your return.
I hope you now have a better idea the value of compounding, it can make a big difference in your financial future. AAA offers you information in this video series for educational purposes only. Carefully consider objectives, risks, expenses and tax implications before investing.
In our next video, I'll discuss early withdrawals, penalties and maturity options for CDs.