What Is APY and How Is It Calculated?

The annual percentage yield (APY) is the interest rate earned on an investment in one year, considering compound interest. APY is higher when compounding occurs more frequently. By comparing APYs at different financial institutions, investors can select accounts with the highest potential returns. APY is similar to the annual percentage rate (APR) for loans but includes compound interest. The formula for APY is (1+r/n)^n-1, where r is the nominal rate and n is the number of compounding periods. Different investments with the same simple interest rate can yield different APYs due to compounding. APY helps investors compare returns accurately across investments. It considers compound interest and how frequently it compounds to provide a more realistic rate of return. Banks in the U.S. must disclose APY on interest-bearing accounts to inform customers of potential earnings. Accounts can have variable or fixed APYs. Variable APYs fluctuate with economic conditions, while fixed APYs remain constant. Checking accounts typically offer lower APYs due to their immediate accessibility, while savings accounts and certificates of deposit (CDs) offer higher APYs as they involve sacrificing liquidity for better returns. APY reflects the true interest rate earned on an investment by considering compound interest, making it a valuable tool for investors to assess potential returns accurately.