How to Calculate APY on A Savings Account
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Reviewed by Calculator Editorial Team
Annual Percentage Yield (APY) is a crucial metric when comparing savings accounts. Unlike Annual Percentage Rate (APR), which only accounts for the interest earned in a single year, APY takes into account the effect of compounding interest. This guide will explain how to calculate APY, the difference between APY and APR, and provide an example calculation to help you make informed financial decisions.
What is APY?
APY stands for Annual Percentage Yield. It represents the actual yearly interest rate earned on a deposit account, taking into account the effect of compounding interest. Unlike APR (Annual Percentage Rate), which only calculates the interest for one year, APY provides a more accurate picture of the true interest earned over time.
APY is particularly important when comparing savings accounts because it helps you understand the real return on your investment. For example, if you deposit $10,000 into a savings account with a 1% APR that compounds monthly, your balance after one year would be $10,100. However, if the same account offers a 1.04% APY, your balance would be $10,104, showing the impact of compounding interest.
How to Calculate APY
Calculating APY involves understanding the compounding frequency and the APR. The formula to calculate APY is:
Where:
- APY = Annual Percentage Yield
- APR = Annual Percentage Rate
- n = Number of compounding periods per year
The formula works by:
- Dividing the APR by the number of compounding periods per year
- Adding 1 to the result
- Raising the result to the power of the number of compounding periods
- Subtracting 1 from the result to get the APY
Most savings accounts compound interest daily, monthly, or quarterly. The more frequently interest is compounded, the higher the APY will be compared to the APR.
APY vs APR
The main difference between APY and APR is that APY accounts for the effect of compounding interest, while APR does not. This means that APY will always be equal to or greater than APR, depending on the compounding frequency.
For example, if a savings account offers a 1% APR that compounds monthly, the APY would be approximately 1.04%. The difference between the two rates is due to the compounding effect, which means you earn interest on your interest.
When comparing savings accounts, it's important to look at the APY rather than the APR to get a true picture of the return on your investment. This is especially important for longer-term savings goals, as the compounding effect can significantly increase your earnings over time.
Example Calculation
Let's walk through an example to illustrate how to calculate APY. Suppose you have a savings account with an APR of 1% that compounds monthly. Here's how you would calculate the APY:
- Divide the APR by the number of compounding periods per year: 1% / 12 = 0.000833
- Add 1 to the result: 1 + 0.000833 = 1.000833
- Raise the result to the power of the number of compounding periods: 1.000833^12 ≈ 1.010381
- Subtract 1 from the result to get the APY: 1.010381 - 1 = 0.010381 or 1.0381%
In this example, the APY is approximately 1.0381%, which is higher than the APR of 1%. This shows the impact of compounding interest on the total return.
For a more accurate calculation, you can use the APY calculator in the sidebar of this page. Simply enter the APR and the number of compounding periods per year to get the APY.