What is APY (Annual Percentage Yield)?
Annual Percentage Yield (APY) is the real rate of return earned on a savings deposit or investment taking into account the effect of compounding interest.
Key Takeaways
- APY includes the frequency of compounding, giving a more accurate representation of earnings than simple interest rates.
- The higher the APY, the faster your money grows.
- APY is different from APR (Annual Percentage Rate), which does not account for compounding.
APY vs. APR: What's the Difference?
While both APY and APR are expressed as percentages, they measure interest differently:
- APR (Annual Percentage Rate) is the simple interest rate. It reflects the annual cost of a loan or the simple return on an investment without considering compounding within the year.
- APY (Annual Percentage Yield) accounts for how often interest is applied (compounded) to the balance. Whether interest is compounded daily, monthly, or quarterly can significantly affect the APY.
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Why APY Matters
When comparing savings accounts, certificates of deposit (CDs), or money market accounts, banks typically advertise the APY. This allows you to compare products with different compounding frequencies on an apples-to-apples basis.
For borrowers, lenders often advertise the APR to make the rate appear lower. It is crucial to understand which rate you are looking at to make informed financial decisions.