What is Annual Percentage Yield (APY)?

Annual Percentage Yield (APY) represents the real rate of return earned on a deposit account or investment over a year, accounting for the effects of compounding interest. It provides a more accurate picture of investment growth compared to simple interest rates.

How APY Works

  • Unlike nominal interest rates, APY includes the impact of interest being calculated on previously earned interest (compounding).

  • The higher the compounding frequency (daily, monthly, quarterly), the higher the APY for the same nominal interest rate.

Formula:

APY = (1 + (r / n))^n – 1 Where r is the nominal interest rate and n is the number of compounding periods per year.

Example

A savings account offers a 5% interest rate, compounded monthly. The APY would be slightly higher than 5% due to monthly compounding.

Importance

  • Makes it easier to compare savings and investment products.

  • Reflects the true earning potential over a year.

  • Standardized disclosure requirement in regulated financial markets.