The Engine of High-Yield Savings
When you deposit money into a bank, the bank does not put that cash in a vault. They immediately lend it out to other consumers in the form of mortgages and auto loans, charging them 7% to 10% interest.
To compensate you for the use of your capital, the bank pays you a "Yield." The mechanism they use to calculate that yield is almost universally Daily Compounding.
Daily compounding means that at 11:59 PM every single night, the bank's computers calculate the exact amount of interest your balance earned that specific day. They instantly add that microscopic fraction of a penny to your principal balance. The very next day, the new calculation is based on that slightly larger number.
Daily Compounding vs. Monthly Payouts
The most common point of confusion for consumers regarding Daily Compounding is the payout schedule.
If a high-yield savings account compounds daily, why do you only see the interest deposited into your account once a month on your statement?
The bank is executing the mathematical calculation in the background every single night, keeping a running tally on an internal ledger. They do not physically deposit the fractions of a penny into your visible account daily because it would create millions of chaotic micro-transactions on your statement. Instead, they aggregate the 30 days of daily-compounded math, and drop it into your account as a single lump-sum dividend on the last day of the billing cycle.
The APY Illusion
Because daily compounding mathematically forces the money to grow faster than standard annual interest, banks use a specific metric to market their accounts: APY (Annual Percentage Yield).
If a bank offers a "5.00% Interest Rate" that compounds daily, the actual, effective amount of money you will earn over 12 months is slightly higher than 5.00% because of the daily snowball effect. The bank will market this account as having a 5.13% APY.
When comparing savings accounts, Certificates of Deposit (CDs), or Money Market accounts, you must always compare the APY, not the base interest rate, because the APY mathematically normalizes the different compounding schedules, allowing you to compare a daily-compounding account directly against a monthly-compounding account.