Is it better to earn 5% on your money with the interest credited every 3 months or to earn 5% on your money with the interest credited at the end of the year.
The answer is getting interest credited every three months. If your interest gets credited every three months, you start earning interest on the interest you earned (in addition to the interest on your original investment).
The APY takes this benefit into account. Therefore, if interest is credited to your account more frequently than annually, the APY is higher than the interest rate.
For those who are more quantitatively inclined, the way to compute the APY on a CD is as follows:
1. Take the interest rate and divide by the number of times interest gets credited each year. For instance 5%/4 = .05/4 = 0.0125
2. Take that result and add 1 to it. For instance 1 + 0.0125 = 1.0125
3. Here's the tricky part. Take the last result and raise it to a power equal to the number of times interest is credited each year (in this case, 4). This means that you multiply the number by itself 4 times. For instance 1.0125 x 1.0125 x 1.0125 x 1.0125 = 1.0509 (rounded off)
4. Take this result, subtract 1, then multiply by 100.
For instance, 1.0509 - 1 = .0509 x 100 = 5.09%. This is the APY.