APY

APY is the acronym for Annual Percentage Yield.

Annual Percentage Yield

A financial term that represents the real rate of return earned on a savings account, investment, or deposit over a year, considering compound interest’s effects. Unlike simple interest, which only considers the initial principal, APY factors in the interest accumulate on both the principal and previously earned interest.

How APY Works

APY is calculated using the formula:

Loading formula...

Where:

r = Nominal interest rate (expressed as a decimal)
n = Number of compounding periods per year

For example, if a bank offers an interest rate of 4% per year, compounded monthly, the APY would be:

Loading formula...

This slight increase from the stated interest rate is due to the effect of monthly compounding.

Why APY Matters

APY is an essential metric for comparing different savings and investment accounts because it reflects the true earning potential of your money. Accounts with more frequent compounding periods (e.g., daily or monthly) will have a higher APY compared to those that compound annually, even if they offer the same nominal interest rate.

APY (Annual Percentage Yield) and APR (Annual Percentage Rate) are often confused but serve different purposes:

APY

Measures the return on savings or investments, factoring in compound interest.

APR

The annual interest rate charged on loans or credit, excluding compounding effects.

For savers, a higher APY is better because it means more earnings. For borrowers, a lower APR is preferable as it results in lower interest payments.

Key Takeaways

APY represents the real return on savings or investments over a year, considering compound interest.
A higher APY means more earnings on deposits.
It is different from APR, which applies to loan interest.
More frequent compounding leads to a higher APY.

When choosing where to save or invest your money, always look at the APY rather than just the interest rate to ensure you’re getting the best possible return.