One little known consequence of falling interest rates is that the difference between APYs and interest rates is becoming smaller. APY stands for annual percentage yield. The effects of compounding causes APY to be larger than the interest rate. It assumes that the interest that you earn from an account is put back into the account. This allows you to receive interest on your interest. In our blog post, Understanding Interest Rate and APY, you can see the details of how APY is calculated.
As interest rates go down, the differences between APY and interest rate also goes down. At a certain point, the difference is smaller than one basis point (1/100th of a percentage point). When the difference is this small, interest rate and APY will look the same if rates are listed with two decimal places.
The following example shows how the difference shrinks as the rate falls. This example uses daily compounding.
- 5.00% rate, 5.1267% APY
- 3.00% rate, 3.0453% APY
- 1.00% rate, 1.0050% APY
- 0.99% rate, 0.9949% APY
As rates fall below 1.00%, APYs and interest rates look the same if the rates are listed with an accuracy of two decimal places.
So for interest rates under 1.00%, there's not really a need to mention the APY. Hopefully, we'll see rising interest rates at some point, and APYs will once again be significantly higher than the interest rates.