Annual Percentage Yield (APY)

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Annual Percentage Yield (APY)

What is APY?

Annual Percentage Yield (APY) is the annual rate of return on an investment or deposit account that includes the effect of compound interest. It expresses how much an investment will grow in one year when interest is compounded at regular intervals.

Key takeaways

  • APY shows the actual annual growth rate including compounding.
  • More frequent compounding (daily vs. monthly vs. quarterly) increases APY for a given nominal rate.
  • APY is used to compare deposit products (savings, money market accounts, CDs) on an apples‑to‑apples basis.
  • APY reflects compound interest only; it does not account for fees or penalties unless those are explicitly incorporated into disclosures.

Formula and calculation

For a nominal interest rate r (expressed as a decimal) compounded n times per year:

APY = (1 + r/n)^n - 1

To compute the future value X of an initial deposit D after y years:

X = D * (1 + r/n)^(n*y)

Where:
* r = nominal annual interest rate (decimal)
* n = number of compounding periods per year
* y = number of years

Examples

  • Monthly compounding vs. simple return:
  • A nominal rate of 6% compounded monthly:
    APY = (1 + 0.06/12)^12 − 1 ≈ 0.06168 → 6.17% APY

  • A one‑year zero‑coupon instrument paying 6% simple interest yields 6.00% (no compounding), so the monthly‑compounded account provides a higher effective return.

  • Quarterly compounding example:

  • $100 at 5% nominal interest compounded quarterly:
    APY = (1 + 0.05/4)^4 − 1 ≈ 0.05095 → 5.095% APY.
  • After 4 years: X = $100 * (1 + 0.05/4)^(4*4) ≈ $121.99 (vs. $120 with simple interest).

How compound interest works (brief)

Compound interest means interest is periodically added to the principal, and subsequent interest is earned on the growing balance. With each compounding period the account balance increases, so the interest earned in later periods is larger than earlier periods, producing exponential growth over time.

Variable APY vs. Fixed APY

  • Variable APY: Can change at the institution’s discretion and often tracks market or policy rate movements. Most checking, savings, and many money market accounts are variable.
  • Fixed APY: Locked for a set term (common for promotional offers and many CDs). Fixed rates protect you if market rates fall but may cause you to miss improvements if rates rise.

Choosing between them depends on expectations for interest rates and your need for predictability.

APY vs. APR

  • APY (Annual Percentage Yield) measures the actual annual earnings on an investment including compounding.
  • APR (Annual Percentage Rate) commonly describes the annual cost of borrowing and typically does not account for intra‑year compounding; it may include certain fees or finance charges depending on the disclosure.
  • Simple rule: APY describes what you earn; APR describes what you pay. Always read disclosures for how fees are handled.

APY and risk/liquidity

Higher APYs usually reflect some tradeoff:
* Checking accounts typically offer the lowest APY because funds are on demand (high liquidity).
* Savings and money market accounts generally offer higher APYs because funds are less likely to be withdrawn frequently.
* Certificates of deposit (CDs) typically offer the highest APYs among deposit products because they require locking funds for a term and often impose penalties for early withdrawal.

Frequently asked questions

Bottom line

APY is the standard way to compare how much interest an account or investment will effectively earn over one year once compounding is taken into account. When evaluating deposit products, consider APY alongside compounding frequency, account fees, liquidity needs, and whether the rate is fixed or variable.