What is annual percentage yield: APY Explained with Formula, Importance & Comparison

The actual rate of return on your investment over the year, including compound interest, is known as the annual percentage yield, or APY. It allows you to see the potential growth of your investments or savings.

Example:

Anil deposits ₹10,000 into a savings account at a bank that offers 5% annual percentage yield. Compounding (interest earned on interest) increases his money to ₹10,500 after a year. He would only make ₹500 without compounding, but his money grows more quickly with APY.

This table helps you understand how APY works differently from simple interest:

This table shows you the simple interest and the compound interest rate:

This article explains merchant payments and focuses on how merchants can profit from APY on their deposits.

What is APY?

The real rate of return you receive on your investment over a year, including compound interest, is known as the annual percentage yield, or APY. It shows the amount that your investment increases over time as interest is added.

Example: Anant’s Business Savings

Anant, a businessman, maintains ₹1,00,000 in a bank account that offers 10% annual compound interest. This is how his wealth increases:

• Year 1: ₹1,00,000 + 10% = ₹1,10,000
• Year 2: ₹1,10,000 + 10% = ₹1,21,000
• Year 3: ₹1,21,000 + 10% = ₹1,33,100

Because the interest is compounded once a year, the annual percentage yield (APY) is 10%. Due to more frequent compounding, the annual percentage yield (APY) would be higher if the bank compounded interest every month.

This table helps you understand how compounding frequency affects APY:

The table shows that more extended compounding periods result in higher APY and more money earned, even with the same interest rate. Compared to ₹10,000 with annual compounding, Anant would receive ₹516 more in a year with daily compounding.

Key takeaways:
 

• APY includes compound interest, so it’s higher than the simple interest rate.
• More frequent compounding means more money over time.
• Always check APY to compare different investment options.

APY Formula and Calculation

APY (annual percentage yield) is the actual return you receive when compound interest is taken into account. By showing the rate of interest changes to your money it allows the comparison of various investments.

Example: (Aman Explains APY to Mohit)

Aman explains to Mohit how to figure out the annual percentage yield (APY) for his ₹50,000 fixed deposit, which is compounded quarterly at 8% interest (every three months). Here is the formula:

APY= (1 + r/n)ny
 

• r = annual interest rate (8% or 0.08)
• n = number of compounding periods per year (4, since quarterly)

Calculation:
 

1. Divide the annual rate by compounding periods: 0.08/4=0.02
2. Add 1: (1+0.02=1.02)
3. Raise to the power of compounding periods: (1.02)4=1.0824
4. Subtract 1: (1.0824−1=0.0824 or 8.24% APY)

Mohit’s ₹50,000 grows to ₹54,120 in a year (₹50,000 × 1.0824), not just ₹54,000 (simple interest).

This table helps you see how compounding frequency changes APY for the same 8% rate:

Key points:
 

• More compounding periods mean a higher APY and more money.
• APY is always equal to or greater than the stated interest rate.
• Use the formula to compare banks or investments offering different compounding schedules.

Aman shows Mohit that quarterly compounding results in ₹120 more than annual compounding, even at the same 8% rate.

What is the difference between APY and APR?

Using Karan's example, the following table clearly shows the distinction between APY and APR:
 

Key Takeaways:
 

• APY = Your earnings grow faster (savings, deposits).
• APR = What you owe (loans, credit cards).
• Karan earns more with APY but pays exactly what the APR states on loans.

Karan can better understand why his investment grows more quickly (APY) than his loan interest (APR), thanks to this table.

(Note: APY is only guaranteed to be higher than APR when comparing the same nominal rate with the same compounding periods (APY ≥ APR).

Conclusion

Because of compound interest, APY helps you determine how much your money will grow over a year. APY gives you a more accurate view of your earnings than simple interest because it takes into account when interest is added, whether it be daily, monthly, or annually. 

For instance, if interest compounds constantly, an investment of ₹10,000 at 10% APY will yield more than ₹1,000 in a year. When selecting investments or savings accounts, always compare the annual percentage yield (APY) as a higher APY indicates faster growth for your money. It's the most effective way to demonstrate compounding's true power over time.

FAQs

What Is a Good APY Rate?

APY rates fluctuate; a reasonable rate today may not be tomorrow's. When the Federal Reserve raises interest rates, savings account APYS usually increase, offering better returns when money is tight. High-yield accounts often provide competitive APYs.

Is APY paid monthly?

No, as the name implies, it is calculated once a year, taking into account how compounding works.

Is APY good or bad?

APY, or Annual Percentage Yield, is a helpful way to understand how much you can earn from your savings or investments at a bank. It gives you a clearer picture of your returns than just looking at interest rates alone.

What is APY vs interest rate?

The Annual Percentage Yield (APY) reflects your potential earnings on savings by factoring in compounding, which includes interest on both your deposit and previously accrued interest. In contrast, interest rates for loans represent the basic cost of borrowing and do not account for compounding.

Where can I find the best APY?

Check online banks, credit unions, or compare rates on financial websites; they often offer higher APY than traditional banks.

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