Annual Percentage Yield (APY)

Overview, Calculations, and Comparison to APR

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Annual percentage yield (APY) is a helpful way to evaluate how much you earn on your money. Instead of simply looking at a quoted interest rate, you get a better idea of your true potential earnings when you use APY.

What is APY?

APY tells you how much you’ll earn with compound interest over the course of a year. When you deposit funds into a savings account, money market, or certificate of deposit (CD), you’ll earn interest.

APY can show you exactly how much interest you’ll earn. With this information, you can compare options – you’ll be able to decide which bank is best, and whether or not you want to lock up your money for a higher rate.

When talking about your savings, a higher APY is better.

What Makes APY Unique?

APY is useful because it takes compounding into account (a simple “interest rate” does not). Compounding happens when you earn interest on interest that you previously earned – which means you’re earning more than an interest rate might suggest.

Example: you deposit $1,000 in a savings account that pays a 5% annual interest rate. At the end of the year, you’ll have $1,050 (assuming interest only gets paid once per year). However, your bank might calculate and pay interest monthly. In that case, you’d end the year with $1,051.16, and you would have earned an APY of more than 5%. The difference may seem small, but over many years (or with larger deposits), the difference is significant.

Single payment per year: if interest is calculated and paid only at the end of the year, your bank would add $50 to your account at the end of the year.

Monthly compounding: if interest is calculated and paid monthly, you’d get small additions every month (notice how the earnings increase a little every month).

PeriodEarningsBalance
1 $       4.17 $  1,004.17
2 $       4.18 $  1,008.35
3 $       4.20 $  1,012.55
4 $       4.22 $  1,016.77
5 $       4.24 $  1,021.01
6 $       4.25 $  1,025.26
7 $       4.27 $  1,029.53
8 $       4.29 $  1,033.82
9 $       4.31 $  1,038.13
10 $       4.33 $  1,042.46
11 $       4.34 $  1,046.80
12 $       4.36 $  1,051.16

APY accounts for these more frequent calculations, so it’s more accurate than an interest “rate.” Fortunately, you’ll almost always see the APY quoted from banks – so you don’t have to do calculations yourself (but you can calculate APY yourself).

APR vs. APY

Annual percentage rate (APR) is similar to APY, but it does not take compounding into account. It is a simpler way of handling interest.

Unfortunately, is APY more accurate than APR in some situations (because it tells you what a loan really costs as interest costs compound), but when you borrow money you typically only see the APR. In reality, you might actually pay APY – which is almost always higher with certain types of loans.

Credit card loans are a good example of the importance of understanding APR vs. APY.

If you carry a balance, you pay an APY that is higher than the quoted APR. Why? Because interest charges are added to your balance each month, and in the following month you’ll have to pay interest on top of that interest (this is similar to earning interest on top of interest you’ve earned in a savings account).

The difference might not be huge, but there is a difference. The larger your loan and the longer you borrow, the bigger that difference becomes.

With a fixed rate mortgage, APR is more accurate because you won't add interest charges and increase your loan balance. However, there are some fixed rate loans that actually grow (if you don’t pay interest costs as they accrue). For more information, learn about different types of APR.

How to Calculate APY

Calculating an investment’s APY can be tricky. If you want to just find out what an APY is with a spreadsheet (like Excel or Google Sheets), here's the process:

  1. Create a new spreadsheet
  2. Enter the interest rate in cell A1 (interest rates need to go in decimal format)
  3. Enter the compounding frequency in cell B1 (use 12 for monthly, 1 for annually, etc.)
  1. Paste the following formula into any other cell: =POWER((1+(A1/B1)),B1)-1

A sample spreadsheet is available on Google Docs – already filled in with these examples.

For example, if the stated annual rate is 5%, you’ll type “.05” in cell A1. Then, for monthly compounding, you’ll enter “12” in cell B1. Note that for daily compounding you can use 365 or 360 depending on the institution.

In the example above, you’ll find that the APY is 5.116%. In other words, a 5% interest rate with monthly compounding results in an APY of 5.116%. Try changing the compounding frequency and you’ll get an idea of how the APY changes. For example, you might show quarterly compounding (4 times per year) or the unfortunate 1 payment per year (which just results in a 5% APY).

The APY Formula

If you like doing math the old fashioned way, here’s how to calculate APY:

APY = (1 + r/n )n – 1 where r is the stated annual interest rate and n is the number of compounding periods per year.

Finance people will recognize this as the Effective Annual Rate (EAR) calculation.

How to Get the Best APY

APY is higher with more frequent compounding periods. If you're saving money in a bank account, find out how often the money is compounded. Daily or quarterly is usually better than annual compounding – but check the quoted APY for each option just to be sure.

You can also pump up your own “personal APY”. Look at all of your assets as part of the larger picture.

In other words, don’t think of one CD investment as separate from your checking account – they all go together and should be considered one. Think of yourself as the Chief Financial Officer of You, Inc.

To pump up your personal APY, find ways to make sure that your money is compounding as frequently as possible. If two CDs pay the same interest rate, pick the one that pays out interest most often and has the highest APY. Your interest payments will automatically be reinvested – the more frequently the better – and you'll start earning more interest on those interest payments.