What Is APY and How Is It Calculated?

The Annual Percentage Yield (APY) is the interest rate earned on an investment over a year, factoring in the effect of compounding interest. A higher APY means a higher return. It's an important metric for comparing different financial products as it reflects the actual rate of return. Unlike the Annual Percentage Rate (APR), which is used for loans and does not consider compounding, APY accounts for the frequency of compounding periods; the more frequent the compounding, the higher the APY. Different types of accounts, such as savings and checking accounts or certificates of deposit, offer varying APYs, often correlating higher yields with greater restrictions or risks. APY is calculated using the formula \((1+\frac{r}{n})^n-1\), where \(r\) is the nominal rate and \(n\) is the number of compounding periods. The practical importance of APY lies in its ability to provide a standardized measure for comparing the potential growth of investments under different compounding schedules.