APY (Annual Percentage Yield) is the real rate of return on a savings account or investment, accounting for the effect of compound interest over one year.
How APY Works
APY tells you exactly how much your money will earn in a year, factoring in how often interest compounds. A savings account advertising 5.00% APY means your money will grow by exactly 5% over 12 months, regardless of whether interest compounds daily, monthly, or quarterly.
The formula is: APY = (1 + r/n)^n − 1, where r is the nominal rate and n is the number of compounding periods per year.
Why APY Matters
APY is the only fair way to compare savings products. Two banks might both advertise a 5% rate, but if one compounds daily and the other compounds annually, the daily-compounding account earns slightly more. APY normalizes this difference so you can compare directly.
Real-World Example
A high-yield savings account offers 5.00% interest compounded daily. The APY is: (1 + 0.05/365)^365 − 1 = 5.127%. On a $10,000 deposit, that extra 0.127% means an additional $12.70 per year compared to annual compounding.
Frequently Asked Questions
What is the difference between APR and APY?
APR is the annual cost of borrowing money (used for loans). APY is the annual return on saved money (used for deposits). APY includes the effect of compounding; APR does not.
Is APY guaranteed?
For variable-rate savings accounts and CDs, the APY can change. Only fixed-rate CDs guarantee the APY for the full term. High-yield savings account APYs fluctuate with the federal funds rate.
How is APY calculated on a savings account?
Banks calculate interest on your daily balance, compound it at the stated frequency, and credit it to your account (usually monthly). The APY reflects the total effect of this compounding over a full year.