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What is the annual percentage yield (APY)?

Annual Percentage Yield definition

What is APY? The annual percentage yield (APY) is a normalised rate of return on an investment calculated on the compounding period of one year. It’s the return received annually. 

Annual percentage yield (APY) means the actual rate of return, or the real rate of return, received by a lender over the period of a year if the interest is compounded.

Key takeaways:

  • APY is a measure of the total amount of interest you can earn on an investment in one year, expressed as a percentage of the initial investment.
  • APY takes into account the effects of compounding, which means that the interest you earn on your investment is reinvested and earns even more interest over time.
  • APY is a useful way to compare different investment options, because it provides a standardized measure of the total return you can expect from each investment.
  • When comparing APYs between different investments, it's important to consider any fees or other costs associated with each investment, as these can reduce the overall return you earn.

An advantage of annual percentage yield is that the interest rate is calculated on a compounding basis and added to the balance right away.

Formula for calculating compound interest

How to calculate APY

The APY may be a fixed or variable, and it indicates the rate of return one may earn over a one year period on deposits such as savings accounts, government bonds or shares in a company. An APY is always represented in terms of a percentage.

The APY formula below describes the APY calculation. 

The APY formula below describes the APY calculation. 

Annual percentage rate (APR) vs annual percentage yield (APY)

The annual percentage rate (APR) is the actual annual cost over a loan’s term or income received on an investment amount. ARP may take into account any additional costs or fees related to the transaction.

The difference between APY vs APR is that the APR does not take into account compound interest. APR only considers simple interest. This is why a loan’s annual percentage yield is higher than its annual percentage rate.

Annual percentage yield (APY) example

Let’s imagine we have to calculate the APY on a principal amount of $100 with a compound interest rate of 6%. The interest rate is calculated on a quarterly basis in this scenario.

Here, r = 6% or 0.06

n = 4, since the rate of interest is on a quarterly basis

Therefore, APY = (1+0.06/4)4-1 = 6.1364%

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